Small businesses are the cornerstone of the American economy. Each year, 2 out of 3 new jobs in the private sector come from small businesses.
Still, for many entrepreneurs, meeting business loan requirements is a fantasy. Depending on the type of business you own, your ability to get funding is the key to your success.
Understanding how to navigate the lending process can help improve your chances. Check out this comprehensive guide of the top five things to know about business loan requirements.
1. Finding a Lender
Finding a lender willing to finance your dreams is possible, but not common when first starting out. There are several places to find lenders who will consider funding your business.
Angel investors are individuals who use their private money to finance a business. These investors usually work alone but are sometimes part of larger networks, like the Angel Capital Association, that seek out certain types of businesses to fund.
Unlike larger investment groups, an angel investor is more likely to fund a project for personal reasons. For example, an investor wants to see a particular industry grow or has previous career experience in a certain sector.
Use your private network of friends and colleagues to find an angel investor. Attend events in your area for startups as these are environments where angel investors are most likely to network.
Angel investors are your best bet for funding with an unconventional idea that a traditional bank believes too risky. These investors have flexibility with their cash and a reputation for taking chances on entrepreneurs they believe in.
When most people think of business loans, they think of banks. Before the Great Recession, your local bank was the most common place for a small business owner to get a loan.
The list of small business loan requirements during this time was pretty basic an universal. Following the recession, banks are one of the most challenging sources of funding for a small business.
Until your business is established, you may have challenges finding a bank willing to lend money to you. Look for banks that advertise themselves as a small business lender.
These banks are more likely to have loan requirements that are realistic for a company your size. Either way, banks want to work with only the top applicants to reduce risk.
People advise starting a relationship with a lender so they can speak to your credibility when you need a business loan. Consider allowing a branch manager to consult with you on the best products for your business and how you can qualify over time.
This option allows you to create a relationship while making your current bank branch a resource for your business. With a personal relationship, the branch manager and its associates can better help you find loopholes or special perks that can lead to funding down the road.
The backup plan to this option is to always maintain a great credit history and stable annual revenue. When the employees in your branch turnover, this will help you prove your credibility with the new team.
One way small businesses get funding is through microloans offered by nonprofits. A microloan is usually $50,000 or less and caters to economically disadvantaged or minority business owners to help stimulate growth in a community microloans
o loans are government funded and can only be used for specific purposes like equipment or inventory. If you want to purchase real estate or refinance existing debt, you need to find another source of funding.
Depending on the size of your city, your local government might offer a community development fund to help local entrepreneurs. The names of these funds vary but contacting your economic development office is a great place to start to get a list of resources.
There are online peer-to-peer lending sites that also offer micro lending options for entrepreneurs. If you are still in the startup phase, microlending is one of the most viable options for raising capital.
The Small Business Administration offers a series of funding options for small business owners. The SBA doesn’t offer the loan directly to a business but instead backs a loan you get from one of the SBA’s bank partners.
In the event you can’t repay the debt, the SBA becomes responsible for part of the loan. Small business owners seeking to qualify for an SBA loan should expect a long vetting process. The SBA needs to ensure that you are a low investment risk.
Most SBA loan applications are accessible online. Plan a few months ahead of when you need the funding to begin getting your paperwork in order.
2. Creating a Business Plan
Writing a business plan is, by far, one of the least exciting aspects of pursuing your dream. To qualify for funding and gain the confidence of lenders, however, writing a business plan is necessary.
Make sure the business plan is detailed and caters to the interests of the reader. Lenders want thorough plans for growth and accurate revenue projects. Extend your forecasts over the length of five and ten years.
A well-written business plan includes goals, risk factors, use of proceeds, prior and projected financial statements. It can take months to prepare a business plan so begin preparing months in advance.
If writing isn’t your strong suit, consider using a professional service to write a polished business plan for you. The goal with a business plan is to leave the impression that you will be the best custodian of the lender’s money. A well-designed business plan can help do just that.
3. Building Your Reputation
Your personal credit score helps lenders and creditors decide whether or not you are trustworthy. A business credit score has the same effect on loan officers.
The three main credit bureaus for business credit history are Experian, Equifax, and DUN & Bradstreet. Your business credit score rating ranges from 0 to 100 getting better as you make on-time payments over time.
Traditional lenders, like banks and credit unions, require a strong business credit score in order to qualify for a loan. If your business has no established credit history, it can have the same effect as having a poor credit history.
Kickstart your business credit history by applying for a paydex number with DUN & Bradstreet. Obtaining a paydex number is free but your score won’t really begin to improve until you have four vendors reporting your on-time payments.
Your company size, history of judgments, liens, and bankruptcies, and age of credit accounts all impact your overall business credit score. In addition to reviewing your history, the credit bureaus attempt to measure your risk of business failure.
Ask vendors in advance of setting up an account whether they report to the major credit bureaus. This can be tricky if they only have your personal credit information on file. When you have no established business credit, personal credit information is often used instead.
Research companies that will accept your EIN alone and report to the business credit bureaus on your behalf. Over time this increases your borrowing power so that you qualify for large amounts of financing.
Working with the right team of accounting and legal professionals can help you easily meet business loan requirements. You never want to guess at your licensing status or whether or not government regulations have changed since you started your company.
Consult with professionals to discuss compliance requirements for your industry. Use a certified public accountant to create your financial statements and balance sheet. These may be available free online, but miscalculating key information can make you appear dishonest or not competent enough to manage finances.
Always go over numbers with your accounting team to understand what figures mean. The accountant can only produce information using the documents you provide. Going over the numbers in detail prevents the chance you forgot to include some income or expenses.
Since you handle the daily operation of the business, you are the best person to double check the accountants work and be sure everything looks correct. Even if you don’t like dealing with numbers, throwing all your invoices and receipts into a shoebox isn’t a solution.
Hire a bookkeeper to help you with weekly or monthly financial reporting. This saves hours of time at the end of the year when your accountant begins preparing your taxes. When you apply for a business loan, the streamlined financial information can help speed up the application process and reflects that you run a professional business.
Ask your accountant to create a profit and loss, balance sheet and aging statements for your accounts receivable and accounts payable each year. These are common documents needed when applying for a business loan.
The cost of document preparation and contract review aren’t cheap. But the investment is worth it if it gives you the opportunity to expand your business and sustain yourself in the long term.
Once you have an established business credit history, a business plan and the right compliance team in place, you are ready to pursue a small business loan. Planning in advance allows you choices in the source of your financing.
Traditional banks are one of the most common lenders for small businesses. Unfortunately, the lending amounts dropped following the recession in 2007. This opened the door for online banks and lenders to create loan products to help business owners find financing.
The loan requirements with online lenders are usually much more lenient but at a cost. Interest rates are higher with the shorter lending periods and relaxed requirements. The benefit of a quick application and funding process makes this an ideal option for some small business owners.
Small business financing comes with the need for collateral or high fees to minimize the risk of nonpayment.
Secured and Unsecured Debt
Alternative lenders use high fees instead of tangible assets to circumvent risk. When a lender requires one of your tangible assets as a condition of loan approval, it is called secured debt.
Unsecured debt does not require any form of collateral. Instead, lenders find other ways to profit from the loan in the short term. Expect unsecured debt to be more expensive to borrow. Most traditional banks offer secured debt, long lending periods and low interest rates.
It takes much longer to receive a large loan with good terms than it does to receive a small, high-interest rate loan. The SBA, for example, loans an average of $371,000 each year with competitive interest rates. But expect a slow application process and funding may not be available right away.
Banks also have a slow application process relative to online lenders. Online lenders typically have funds available within a few business days following the approval of a loan application. The loan application is generally approved or denied within minutes online.
Understanding Business Loan Requirements
Financing an established business is a straightforward process when you’ve taken the time in advance to get organized. Startups and non-employer businesses may have a harder time meeting business loan requirements.
A non-employer business is a small business that has no paid employees. These businesses often have little startup capital needs so vendor payments that help establish business credit history may be non-existent.
No matter what type of business you own, chances are that you have experience solving problems. Tackle your list of loan requirements as another area where you can bring inventive solutions.
You can confidently assume that most lenders will want to see the same information as a part of their business loan requirements so it’s best to get a system in place you can stick to. For more tips on business financing, check out our website.