Which is the most important requirement a business needs to secure a bank loan to fund its operations? Credit report? Business plan? Collateral? Guarantor?
Every business at some point in time will need access to working capital to pay for new employees, office space, materials, equipment, marketing, and more. Although the average cost of starting most businesses in the united states is ,000 or less, not every aspiring business owner has the savings to get up and running.
This is where business loans come in. But just like most good things, business loans don’t come easily. The most common option for acquiring funding is through a loan given by banks as well as other financial institutions. In present days, obtaining a loan is not as easy as it used to be.
5 Most Important Requirements a Business Needs to Secure a Bank Loan to Fund Its Operations
Every lender has a slightly different method of compiling information from interested borrowers. But there are still several requirements that business lenders seek. Although not all lenders will require a full list of documents and requirements, it is safe to assume that you will need to provide credentials such as your personal credit score, annual revenue, and time in business.
Howbeit, below are the five most important qualifications or requirements you will likely need for your business loan application:
- Credit Score
It is always a reality shock for first-time small business borrowers to learn that the arguably single most important factor impacting a business’s loan eligibility is actually the business owner’s personal credit score. But since most businesses don’t have much of a business credit history to speak of, the owner’s personal credit is the most reliable insight a lender can get into how the business will handle its debts.
Note that from the lender’s perspective, if your personal credit score shows that you are a trustworthy borrower, it is likely that you will be a trustworthy borrower as a business. In most cases, you will need a credit score of at least 600 to acquire a business loan.
Under the Fair Credit Reporting Act, you are entitled to a free annual credit report from each of the three major credit bureaus: Equifax, Experian, and TransUnion. You can get all three together or space out your credit report requests over time. Aside these major credit bureaus, there are a lot of “free” credit reports and scores floating around. But unfortunately, lenders typically don’t use these scores when making credit decisions.
It is advisable you have a personal FICO credit score, which you have to pay for. The FICO scoring system is used by 90 percent or more of lenders, so this is the credit score that actually matters. If your personal score isn’t stellar, an excellent business credit score can sometimes offer support to your application.
- Time in Business
Since almost 20 percent of businesses fail within the first year, a longer time in business shows that your business can withstand the uncertainty of tough times. As straightforward as this business loan requirement may be to report, its implications can be frustrating for brand new entrepreneurs.
If being a very young business is holding you back from certain loan options or lower interest rates, the only thing you can do is wait it out and reapply when you’ve been around a bit longer. Ultimately, the threshold that you should keep in mind is two years.
If your business is under two years old, it doesn’t make it impossible to get a business loan, but it does limit your options. Although banks may be less likely to lend to businesses less than two years old, online lenders will often have more flexible requirements with regard to your time in business.
Howbeit, if you have a newer business, the best thing you can do to strengthen your loan application is to have a solid business plan showing how you plan to grow revenue and profit in the next three to five years. Similarly, you will want to highlight other strong business loan application requirements you meet, such as a solid personal credit score and any collateral you can offer up.
- Cash flow and income
Cash flow can make or break your business. A steady and healthy stream of cash proves to lenders that you are capable of sustaining the loan payments. It is ideally a representation of your business’s health. Coupled with income, lenders will most likely look at expenses to determine how profitable your business is.
If your company routinely deals with invoices, you’ve most likely experienced the headache of delayed payments. These unpaid invoices can have a serious impact on a company’s turnover or cash flow. Fortunately, there’s a valuable financing option for business owners: invoice factoring.
Commonly referred to as accounts receivable financing, invoice factoring is a financial transaction where a business sells their unpaid invoices to a third – party lender. So instead of waiting for your customers to pay their invoices, you will be provided with extra cash flow to help you achieve your business goals, meet payroll, and pay operating bills on time each month.
Make sure you have accurate monthly financial statements from the past two years on hand. The lenders will want to look at specific metrics like the current ratio, which is your current assets divided by current liabilities.
Many lenders will also ask for copies of your bank account transactions so they can confirm cash flows that are reflected on your financial statements. Remember, the qualifications for a business loan depend more on growth in cash flow and less on revenue.
- Industry
Have it in mind that the type of industry your business falls under can be a deciding factor for many lenders. And in some cases, they may lean away from certain industries that are considered risky. In fact, businesses deemed to be socially undesirable tend to be rejected most.
If you own a seasonal business, such as a golf course, landscaping company, or ice cream truck, you most likely understand the importance of ample cash flow to sustain your company during the off season. Given the ups and downs of these types of businesses, getting approved for a business loan may prove difficult.
Fortunately, there are solid lenders available that are geared more toward seasonal businesses. Meanwhile, the list of restricted industries varies from lender to lender, in both number and type, but if your business falls into one of the categories on your preferred lender’s list, you may need to look to another lender or funding option.
- Collateral
Every lending source wants to reduce their risk when giving a loan. One of the ways they do this is by asking for additional financial collateral to secure the loan. This is usually done in the form of a company’s accounts receivable, equipment or any other easy – to – sell asset.
One of the additional qualifications for a business loan may be for the company’s owner to provide a personal guarantee to their loan, or pledge additional collateral such as personal real estate or other financial resources. In some cases, like equipment financing or commercial real estate loans, the loan is backed by the very thing it is being used to purchase.
If you fail to make payments on your equipment, the lender can seize the equipment. If you fail to make your commercial mortgage payments, the lender will put a lien on your property. In other cases, you will need to have your collateral approved by the lender.
For instance, if you are financing a big business purchase or seeking a working capital loan, a lender may require you to use an asset you already own as collateral. How much collateral you need depends on several factors, including your credit history, loan amount, and the purpose of the loan
Conclusion
Entrepreneurs take out business loans for an unending variety of good reasons, but at the end of the day, the requirements you need to meet to get a business loan will be specific to the loan product and the lender. By preparing in advance for this, you will be better able to qualify for the right loan product from the right lender on your first try.