Small business loan requirements can be complicated. There are a multitude of lenders in the market to meet the diverse funding needs of small business owners; each lender has their own set of loan qualification criteria.
Whether you’re looking for a traditional bank loan or considering alternative lenders, having an idea of the qualification prerequisites of the financial institutions can help smooth the process. In this blog, we will clarify some of the primary loan requirement benchmarks required by traditional and alternative lenders for a small business loan.
Qualifications for a Small Business Loan
1. Business credit score
A business credit score is one of the primary factors in securing a loan, as it gauges your company’s creditworthiness. It is a numerical rating assigned to your business by credit bureaus such as Experian, Equifax, and Dunn & Bradstreet. It helps the lenders determine your company’s risk profile and how diligently your business has managed its debts. Generally, an Equifax business credit score ranges from 101 to 992, with a score of 550 and above considered to be good.
Traditional lenders seek businesses with a higher business credit score, often 700 and above. On the other hand, alternative lenders are flexible when it comes to business credit score, typically offering loans to businesses with fair to excellent credit. The score also influences more than just the loan approval, as it often impacts the amount of the loan and the accompanying interest rates. A stellar credit score can unlock the most favorable loan terms. If you are aiming to build your business credit, follow our tips on how to improve business credit score.
2. Personal credit history
Even though your business is being assessed for a loan, lenders will typically look at your personal credit score as well credit history, especially those of principal owners. Their financial behavior personally could dictate the small business’ potential creditworthiness, especially for new businesses without a long-standing credit history. Lenders often associate good personal credit score with the business owner’s capability to handle debt, and draw parallels from it toward business risk assessment. Traditional lenders might seek a personal credit score of 680 or more, whereas alternative lenders may accept lower scores.
3. Years in business
Longevity is huge in obtaining business loans, as it often acts as a barometer for stability and risk of a small business. Most traditional lenders prefer businesses that have been operational for at least two years, as they are more likely to stay operational and repay the loan on time. However, alternative lenders may support newer ventures and entertain loan applications from businesses that have been in business for a minimum of six months. This flexibility can be a lifesaver for budding entrepreneurs seeking financial aid.
4. Annual sales revenue
Lenders use annual sales revenue and accounts receivable as a key metric to gauge a business’s financial health, its profitability, and its capacity to repay a loan. Typically, banks look for businesses with higher annual gross sales revenue, often around $700,000, to minimize their risk. In contrast, alternative lenders might extend loans to businesses with more modest annual sales revenue of around $250,000. Alternative lending platforms can be hugely beneficial for smaller businesses, especially if they are experiencing a temporary dip in revenue.
5. Business size and industry
Lenders often categorize industries based on the associated risk. Because of their inherent volatility, business industries like hospitality and tourism may be viewed with more skepticism. Sectors like gambling, online gaming, drug dispensaries, and money lending often find it tougher to secure loans due to their controversial nature.
If you’re aiming for an SBA loan, ensure you qualify as a ‘small business’ by their definition and have not defaulted on any past government loans. Alternative lenders, on the other hand, are more flexible when it comes to business size but may avoid lending to some high-risk industries and not-for-profit sectors.
6. Balance sheet
A balance sheet provides a snapshot of a business’ assets, liabilities, and equity at a particular point in time. It is an extremely important document for lenders to examine as it provides an assessment of financial health, focusing on current liabilities, lines of credit, long-term debts, and the owner’s equity. Businesses seeking loans need to maintain a lean debt profile as excessive debt can be flagged. A cleaner balance sheet will increase the chance of loan approval.
7. Bank statement and ratings
Bank statements can reveal much about a business’s financial stability. Lenders can look at the average monthly balance, ensuring the business isn’t living paycheck to paycheck. While traditional lenders may request up to six months of bank statements, alternative lenders could settle for three. But the emphasis remains on consistency in maintaining a decent balance.
Banks may also look at the transaction history within the accounts to verify sales or otherwise. Based on your past account balance and dealings with the bank, the bank assigns a rating to your business account. A low rating indicates past defaults or problematic transactions, and it can slow down or lower the chance of your loan approval.
Apart from bank statements, there are other documents required to apply for financing. Read our guide to know what documents are needed for a small business loan.
8. Business cash flow
Cash flow is the lifeblood of any business, as business cash flow is essentially the net amount of cash moving in and out. It clearly shows the financial health by revealing the net amount remaining after settling all business-related expenses. Lenders are very in tune with this number and also look at the debt service coverage ratio (DSCR) before and after the loan disbursal. The DSCR is calculated by dividing net operating income by total debts. A favorable ratio of 1.25 or more assures the lenders of a business’ ability to handle its debt, and the higher the ratio, the better chances of loan approval.
9. Income tax returns
Income tax returns, both personal and business, are typically requested by lenders from the preceding financial year. This will help them identify any potential red flags like tax defaults or identify any signs of tax fraud. A clean tax return will reflect financial responsibility and enhance the odds of loan approval.
Collateral is a tangible asset that a borrower offers to secure a loan. It is a safety net for lenders, ensuring they have the means to recoup their money if a borrower defaults. If a loan is unpaid, the lender has the right to seize the collateral. Traditional lenders are more inclined to request collateral, whereas alternative lenders might offer more flexibility in this regard as they offer business loans without collateral with the help of personal guarantee.
11. Personal Guarantee and Assets
A personal guarantee is a commitment by the business owner, which assures the repayment of the loan personally even if the business fails. Unlike collateral, a personal guarantee is an assurance based on trustworthiness. Most alternative lenders seek a personal guarantee in the absence of collateral, tying the individual’s assets to the loan’s security.
12. Business Plan
A business plan outlines the goals, strategies, and financial projections of a company. Having a strong business plan will help lenders evaluate the business’ potential profitability and ability to repay the loan. While it typically has details like market analysis, organization structure, and financial forecasts, some alternative lenders don’t require it. Still, it is always beneficial to have one prepared. Follow our guide on how to write a business plan for a loan.
Understanding a lender’s prerequisites is the first step to securing a small business loan. For additional information, visit our article “How to get a small business loan” to navigate various loan types and their application procedures.
About the Author
Kelly Hillock is the content marketing manager for SmallBusinessLoans, where she writes and edits articles for small business owners. Kelly has over eight years’ experience in copywriting across a variety of industries, focusing on entrepreneurship and finance. She has a Bachelor of Arts in journalism from San Diego State University.