Obtaining a loan can be a challenge for many small business owners. Entrepreneurs don’t realize that even preparing to apply for a loan can take years of foundational work. Some others don’t know about alternative lending options that can help newly established businesses, or those with an immediate need to get the money they require. Luckily, there are a number of ways to improve your chances of getting a loan approval. The following strategies explain how to get a business loan successfully.
Four strategies to help you get a small business loan
- Get your personal credit in order
When you’re starting out in business, your own financial history will play a major part in your startup’s potential to obtain financing. Almost any kind of loan or credit you get will need to be personally guaranteed. For your business to get the best rates and have the most options, your personal credit score will need to be at least 700. You can check your personal credit score online, and you should do that right away as you prepare to apply for a loan. If you need to improve your credit score, you can start paying down your debts and stop applying for additional credit. Look at your credit report carefully for errors and file for a correction immediately, as you would be surprised how often this can make a difference in your score. If your own financial situation is grim, you may want to wait to get a business loan until you’re in a more financially secure position.
- Build your business credit
Many entrepreneurs don’t understand the importance of business credit. Building good credit for your business is necessary to enable your company to have access to all kinds of small business funding and to gain the best rates and terms. One of the most important elements in calculating business creditworthiness is your operating history. When you start your business, try to establish it as separate entity from you personally as soon as possible. This means getting a local business license and any relevant legal filings (LLC, DBA, partnership, etc.). Your company also needs its own phone number, website and mailing address (even if it’s a post office box). This will have a large impact on demonstrating a stable business history.
Open bank accounts with your business’ name and get a business credit card. You will need to guarantee it personally at first, but this is a major step toward getting a small business loan. Establish relationships with your suppliers and vendors and ask them if you can pay on terms (e.g. net 30 payment). Terms are another type of credit. Use your credit sparingly and pay on time. Even if you don’t need to, use it at least occasionally to demonstrate to future lenders that you are able to manage and pay off debts.
Monitor your credit score often so you can contest any errors and fix areas that need improvement. You can ask for a copy of your business credit report from each of the major credit bureaus (Dun & Bradstreet, Experian and Equifax) or you can subscribe to a credit monitoring service. Remember that business credit is scored on a scale from one to 100 (100 being the best). In general, a score of 75 or higher is needed to secure a traditional bank loan.
- Write a thorough business plan
Presenting a detailed business plan can make a good impression when getting a business loan. Be sure you follow best practices (there are many books and online resources explaining how to write a business plan) and project at least three years out. When it comes to finances, be precise. Research your costs and come up with exact numbers instead of a range when outlining your loan needs. Explain how and why your intended investments will help grow your business. Come prepared with supporting financial documents, including projections, balance sheets and recent tax returns.
Your business plan should address more than finances. You also need to convince lenders and alternative lending companies why your company is a smart investment. Include background information on all your staff and explain why your business is different and better than your competitors. Point out the growth potential in your market and provide your strategies for getting a percentage of that market share.
- Decide which type of loan and lender are best for you
Before diving in and starting an application for a business loan, be sure to research all the loan options. Consider the following during your research:
- Term length: How long will it take you to pay back the loan? What is the useful life of what you’re purchasing with the borrowed money? When will you need to replace the item or reinvest in it again?
- Monthly payment: How much can you afford to pay each month?
- Interest rate: Can you get a good rate now or should you wait until circumstances change?
- Timing: Do you need money now? Or can you wait?
- Risk: Is it better to have a secured or unsecured loan? Can you qualify for an SBA loan? Do you have the right collateral?
- Lender: Should you work with a traditional bank, a microlender or an alternative lender who has less stringent requirements?
- Loan type: Is a conventional loan right for you, or would another loan option like invoice financing, merchant cash advance or a business line of credit be a better fit for your business?
Your business and personal credit scores, your business’ history and your plan to spend the money, among other factors, will help decide which of these options are best for your business.
Factors that determine your chances of getting a small business loan
Lenders factor in a variety of elements when determining whether or not to loan money to your business. These factors also affect the terms and interest rate a lender will offer you. It can help to know what lenders are looking for so you can understand how to get a business loan that fits your financial needs.
- Time in business: The longer you’ve been in business, the less of a risk you appear to potential lenders. Many lenders won’t give a loan to companies that have been in business for less than two years.
- Type of business: Some kinds of businesses are more risky than others, whether because of intense competition, potential liabilities or complicated legal regulations. These include restaurants and bars, clothing stores and money service businesses. Therefore, a lender might decide not to work with certain types of business, charge a higher interest rate on the loan, or require your loan to be personally secured.
- Credit score: Your credit score clues lenders in on how well you’re able to manage debt. If you don’t have a good credit history, a traditional lender likely won’t be willing to take a chance on your company.
- Revenue: Simply put, lenders need to know that you have a constant stream of money coming in to make your loan payment each month.
- Collateral: Businesses often get better terms on their loans if they are secured by collateral. The collateral can belong to the company itself or to its owners. A loan that is secured like this means less risk for the lender and better outcomes for the borrower.
- Economic climate: The federal interest rate varies, and this can impact your chances of obtaining an affordable loan. The lending climate also fluctuates, and banks tend to stay away from small business loans during worse financial times. Though your company doesn’t have control over whatever is influencing the economy, these factors can significantly affect your ability to get a business loan.
Some alternative lenders are turning away from these traditional qualifiers and are looking at new ways to determine potential business success, like social media influence, Yelp reviews and shipping habits.
Why is it difficult to get a business loan?
Quite frankly, lending to small businesses is risky for banks, other lenders and alternative lending companies.
According to the SBA, one-third of new businesses close during their first year, and half will fail by their fifth year.
Those are not exactly good investment odds.
Also, underwriting a large-scale loan costs a lender the same as underwriting a small-scale loan. But a larger loan is more likely to bring in much higher revenue. Lending to small businesses who are looking to take out a small loan is just not as profitable for lenders, so they tend to focus on it less.
Traditional lenders also have high standards and need an intense vetting process because they want to guarantee they are going to make a profit on their investment. They don’t want to loan money to a company that’s going to waste it, go out of business, and default on the loan. Alternative lenders have less stringent requirements, but they tend to make up the difference by charging additional fees and having much higher interest rates.
Since the recent recession, lenders have been dealing with tighter banking regulations that don’t allow for risky investments. In an effort to create a more cautious portfolio, many lenders have significantly raised their standards for small business loans.
You can overcome all of these hurdles with the right education and planning. Understanding how to obtain a business loan, preparing your company for the application process and putting time into honing your company as an ideal loan candidate can pay off in spades. If you focus on your personal and business credit, create a detailed business plan, and research the best loan and lender match, your business will be on track to getting the loan it needs to reach the next step of growth.
This article originally appeared on LendingTree.com on March 29, 2017.
Content sponsored by LendingTree.