Research suggests that of all small businesses started, 82% failed due to a lack of cash flow.1 Obtaining a business loan gives you the power to get your company off of the ground, manage daily operations and harness your future. However, getting there can be tricky if you are unprepared.
Follow our five steps to navigate the application process and improve your chances of successfully securing a business loan.
- 1. Ask the Right Questions
- Before starting the loan application process, you’ll want to establish that your qualifications are adequate to obtain a business loan. To do this, you can ask yourself:
- What is my credit score?
- First thing’s first: Check your credit report. Access a free copy of your personal report from Equifax, Experian or TransUnion and business report from Equifax, Experian or Dun & Bradstreet and analyze for discrepancies. If you identify an error, report it to one of the credit bureaus immediately to have it corrected.
- Typically, lenders prefer to loan to borrowers with a personal credit score of 680 or above and a satisfactory business score. This shows that you are reliable and trustworthy to repay their funds. If you have a low credit score, consider working on boosting your score for a few months before applying or seeking a nonprofit microlender.
- How much cash flow do I currently have?
- Lenders may require a significant down payment or proof of minimum annual revenue to feel secure in their decision. Each lender has the power to set its standards for the minimum annual revenue required. Calculating and understanding your revenue stream is imperative to determine whether you meet a lender’s standards before you apply.
- Is my business experienced enough for a loan?
- Many lenders favor businesses that have been operating for at least two years. Proving that your company can withstand the first few years is important to lenders and viewed as less of a risk than ventures that are just starting out.
- Can I afford monthly repayments with interest?
- Business expenses add up fast – with bills, operational expenses, payroll and emergency funds, it can be challenging to add the cost of a loan plus interest on top. Use the Debt Service Coverage Ratio (DSCR) to calculate a loan amount that you can comfortably afford, including principal, interest and additional fees. A DSCR of 1.25 or higher shows a lender that your business has enough funds to repay the loan and handle unexpected day-to-day expenses.
- To find your DSCR, simply divide your monthly cash flow by the loan payment.2 For example, if your business’ monthly sales are $5,000 and you spend $1,000 on operational expenses, your monthly cash flow is $4,000. Then, add up your repayment amount including principal and interest – let’s say this is $1,000 per month. Following the equation, your DSCR would be 4.
- 2. Determine Loan Intention
- Once you have determined that you qualify for a loan, think about what you are going to use the loan for and what type of loan you will need. Are you looking to start or grow a business? Or simply manage daily expenses? Your answers will determine the type of business loan you can receive.
- 3. Find a Lender That Works for You
- Depending on your loan criteria, credit score and experience, you will likely have a choice of three types of lenders to boost your business: Financial institutions, online lenders and nonprofit microlenders.
- Financial institutions offer a traditional loan experience. Most financial institution lenders require borrowers to have high credit scores and offer collateral to secure a loan. While meeting this standard may be challenging for some small business owners, financial institutions may offer low, competitive interest rate options to approved borrowers. Financial institutions are also often the gateway to Small Business Administration (SBA) loans, including short-term microloans and disaster loans.
- Online lenders provide fast funding to borrowers without collateral or years of business experience. Their small business loans and lines of credit range from $1,000 to $5 million with an annual percentage rate of 6% to 99%.3 Online lenders enable you to get the money you need fast, but with higher rates than financial institutions.
- Lastly, microlenders are nonprofits that offer short-term loans of less than $50,000 to businesses that are too small for traditional loans.3 The application process for a microlender is typically longer and requires financial statements and an in-depth business plan. While the loan is smaller and the rate is higher than financial institutions, these loans allow borrowers with no collateral and unsatisfactory credit scores and financial history to start or grow their business.
- 4. Collect Documentation
- Lenders want to see that you are prepared and have a plan for the credit you are requesting. A great way to do this is to gather any required documentation to streamline the process. Depending on your loan type and lender, you may need to come prepared with:
- A business plan.
- Tax returns and bank statements for your business and personal records.
- Financial statements for your business.
- Any legal documents for your business, including a trademark or franchise agreement, lease agreement for commercial space or articles of incorporation.
- Check which documents are required by your financial lender and collect one or all before applying.
- 5. Apply
- Finally, you’re ready to apply! Take a look at the loans you qualify for and determine the right fit for your business. Complete the application for your desired loan and remember to include all required documentation as well as any other information you would like your lender to review. For example, if your credit report is damaged due to identity theft, consider writing a letter to the lender explaining your situation and proof you have submitted a report to a credit bureau.
We are here to help your business venture thrive – visit our website or call us at 410-272-4000 to learn more.