Many businesses enter the small business loan process unprepared for the scrutiny they could face when seeking a small business loan. Although different lenders will evaluate your business creditworthiness using different metrics, the crux of what they’re trying to determine can really be boiled down to three questions:
Unlike an investor who might be willing to invest in your business today and wait for what’s called a “liquidity event” down the road (think in terms of selling the business or going public), a small business lender isn’t “investing.” A lender profits by accepting your periodic loan payments—starting with the first payment. As a result, lenders dive into your business financials to determine whether or not your business has the financial ability to make all the periodic payments.
Although the revenue threshold will vary depending on the lender (an online lender like OnDeck, for example, might work with a small business that has $100,000 in annual revenue while a more traditional lender would prefer to work with a business with revenues closer to $1 million), if your business isn’t earning any revenue yet, it’s unlikely you’ll find much success with a lender.
A trend among lenders today (including online lenders) is a more frequent periodic payment than monthly. Daily or weekly direct debits from a business checking account is becoming more common. However, to successfully do that, a business needs the right kind of cash flow. A consistent flow of cash into the business on a daily basis is better suited to the more frequent periodic payments and can be easier for the business to accommodate than a larger payment due at the end of the month.
This makes it difficult for businesses in that first year or two to qualify for a small business loan. But that doesn’t mean there aren’t credit options available to them. Vendors often offer credit to their good customers. Other businesses that offer many of the supplies most businesses use on a regular basis, like Staples, Home Depot, or Lowes, also offer credit to small businesses. And, because they report your good credit behavior to the business credit bureaus, they will help you build a business credit profile that will make it easier to get a business loan down the road.
Once a lender determines you are financially able to repay a loan, they look at what you’ve done in the past to determine whether or not they think you will repay it. The red flags in this category tend to focus on your track record.
Lenders are generally trying to make a prediction about what you will do in the future by looking at what you’ve done in the past, if you have no track record—in other words, you have a weak business credit profile—it’s a red flag. This is also why time in business is relevant. Nevertheless, some lenders will work with younger businesses. Many online lenders only require a year under your belt, while most traditional lenders will want to see several years. On the other hand, the U.S. Small Business Administration (SBA) will work with a startup business provided the founder has a good personal credit score and other business metrics are in place. This will likely include adequate revenue and cash flow to make the loan payments.
Your business credit profile is a reflection of how your business meets its credit obligations and there are a number of reasons your business might have a weak profile. It’s possible you just haven’t been in business long enough to build a strong profile. It’s also possible you haven’t taken advantage of opportunities to build business credit in the beginning by seeking trade relationships with your vendors or obtaining a business credit card—building a profile requires prudently using business credit. To build a strong business credit profile you should also avoid using personal credit for business purposes. Using personal credit does not help build your business credit profile.
Although your personal credit score is a reflection of how you meet your personal credit obligations and not your business obligations, it has become a metric many lenders use to evaluate your business creditworthiness. It has even become a go-no-go metric for traditional lenders—so a personal credit score below 680 will make it difficult to secure a loan at the bank. The SBA will sometimes go as low as 650, and many online lenders will work with a business owner with a lower personal score, provided they can demonstrate a healthy and creditworthy business. Nevertheless, most lenders have a personal credit score threshold below which they will not approve a loan.
Depending upon how recent the bankruptcy or judgment might be, it may still be possible to qualify for a business loan, but any financing you’re able to obtain will come at a premium. In the years following your bankruptcy, it’s important to focus on good credit practices and rebuild your damaged profile. Reach out to vendors and suppliers who might be willing to offer you credit terms again and start over. Overcoming a bankruptcy or judgment on your credit profile won’t happen overnight, but with consistent effort and good credit practices, it’s possible.
Building a credit profile that demonstrates to lenders you “will” repay a small business loan takes time, but regularly evaluating your profile to determine where you are and how you’re improving is the first step. Levi King, CEO and co-founder of Nav, suggests, “Dive into your business credit profile and make sure you’re paying attention to what’s happening. You’d be surprised at what a difference monitoring your credit profile makes.”
This might sound like an overly simple answer, but according to a recent survey conducted by Nav, those businesses that regularly monitored their credit were 41 percent more likely to be approved for a small business loan than those that didn’t.
Regardless of the lender you choose, they want to know you will make regularly and timely loan payments regardless of what happens within your business.
It’s not uncommon for a business to fund growth initiatives with a small business loan. For example, in a recent survey conducted by the Electronics Transactions Association, 96 percent of the business owners in the survey were borrowing to enable business growth and anticipated on average a 5X return for every dollar borrowed. Nevertheless, a lender will want to know that your business will be able to make loan payments regardless of whether or not your business achieves that ROI goal.
Access to capital is a challenge for many small businesses, but being aware of potential red flags in your business can help resolve them and improve the odds of a successful small business loan application in the future.