Very often building a business is auto-didactic (self-taught). Along those lines of thinking, so is understanding the small business loan requirements of all business financing institutions.  Knowing what they will likely ask in the approval process of a small business loan or a business line of credit will be important.

At each step of the way as an entrepreneur builds their company, the business owner’s understanding of various financing options will come into play. Let’s go over the 11 facts about business loan requirements that banks and other financing companies will evaluate.

Knowing these factors can save you significant time and money.

Options: Banks/Credit Unions, Online Lenders, Merchant Cash Advances, Invoice Financing

Small business Loans Versus a Business Line of Credit

First, what is a small business loan? A small business loan is a term loan which means the creditor (Bank, etc.) provides a fixed amount of money that is paid back over a fixed number of years on a monthly basis. The loan amount of a term loan is typically a larger sum of money than a revolving business line of credit would provide. Term loans are used to start a business, expand a growing business, or do inventory or equipment financing.  In other words, a term loan is good for long term needs because the amount and time is fixed.

A revolving business line of credit is a preapproved amount of money that can be used for anything the business owner needs but it is usually used for short term working capital to level out the ups and downs of cash flow. A business line of credit doesn’t have to be used and is typically renewed yearly by the financial institution.  A business line of credit can be accessed and returned to the creditor rapidly which minimizes the amount of interest paid while funds are being used.

The Problem With a Bad Credit Score For Business Loan Requirements

Business financing companies consider business owners personal credit score below 600 to be bad credit. If you have bad credit then you will have loan options but the interest rates of those loans are much more expensive. One of the main causes of a small business owners’ low credit score is that everything in your business is likely personally guaranteed which results in many credit inquiries and high credit usage – both impact a business owner’s credit score.  In addition, regardless of whether you use the available balances on your credit cards and loans or not, the credit rating agencies will lower your credit score.

Banks and Credit Union Business Loan Requirements

Banks and Credit Unions are often the first places a business owner will turn to for a business bank loan or business line of credit. And why not? That is where the money is. However, every business owner should know that banks/credit unions are funded by the federal government and depositors. As a result, business financing approvals by banks/credit unions are hard to secure.

You can not just walk into a bank with a great business plan and be approved for a bank loan. Banks and credit unions will ask you to fill out a lengthy bank loan application that will take much effort & time to fill out. The number one business loan requirement that banks and credit unions will be looking for do you have business collateral or personal assets (like real estate with equity in it) to back up the bank loan or credit line. Without that collateral, the chances of being approved are zero. Keep in mind that in some businesses the bank will consider some of your accounts receivable and inventory as collateral so that might help you be approved but this is often only after years in business with a stellar relationship with the banking institution.

Banks and Credit Unions will also look for personal guarantees from all business partners. If you are pledging equity in your home as an asset your spouse will also be required to sign the bank loan contract. The bank will be checking everyone’s credit history and FICO personal credit score via the credit bureaus. They will want to see a 680 credit score or higher along with a credit report that, in their minds, is clean. If you have a silent partner who maybe helped fund the businesses startup that person will also have to sign as a guarantor of the loan and if they have significant assets they may not agree to put those assets at risk which means, in most cases, no loan.

The last business loan requirement the bank and credit union underwriters will be looking at is your business tax returns, personal tax returns, income statement, bank statements, balance sheets, business licenses, and other various other financial statements. The higher your business’s annual revenue the more information the bank will require.

Online Lenders Small Businesses Loans and Lines of Credit For Small Businesses

Online Lenders began popping up when the bank stopped lending due to the 2008 great recession. There was a convergence of banks pulling away from lending to small businesses and technology that could be used to more efficiently approve loan applications for small business loans.

Many online lenders served the small business community and began to eliminate the stringent business loan requirements that banks were asking for like collateral. Online lenders were able to use algorithms to analyze a business’s cash flow, the business owners’ personal credit score, bank statements, business credit score, and debt ratio to predict quickly which business could be approved for business financing.

Unlike a bank or credit union, online lenders are privately funded and therefore don’t have to follow the strict business loan requirements that the government requires. Online lenders also started to offer financing options that banks just couldn’t compete with so the majority of small businesses with yearly revenue under $5 million today are working with an online lender or merchant cash advance company.

Online Lender Financing Solutions Business Line of Credit Requirements

Financing Solutions is a good example of an online lender that mixes technology with the human element.

Financing Solutions will approve a working capital business line of credit of up to $100,000 for small businesses and nonprofits that have yearly revenue of over $400,000. In most cases, the personal credit score for the person signing the contract will need to be 650 or greater.

Financing Solutions’ loan application process is online and takes 2-minutes to fill out allowing the business owner to get a quote the same day. There is no paperwork nor a personal credit score check until after the small business owner decides she/he wants to move forward. At that point Financing Solutions is looking for backup documentation to verify the loan application that includes the most recent business tax return, 4 months of bank statements, and a few other simple to get documents. The line of credit will be set up in 48-72 hours.

Unlike a bank, Financing Solution’s business line of credit costs nothing to set up and nothing until used making it a great cash back up plan for working capital. In many cases, the costs of a Financing Solutions credit line is cheaper than a bank because often small businesses use the credit line for only short term working capital issues.  The funds are used and returned quickly minimizing fees and because it costs nothing to set up and there are no annual fees the business owner only pays while funds are in use.

Merchant Cash Advances and Cash Advance Business Loan Requirements

Merchant Cash Advances (MCA) has been around for about 20 years but has morphed over time into cash advances. MCA’s are business loans that are given to small businesses that have a lot of credit card transactions. An MCA is a loan option that provides a fixed amount of money and the principal/fee is paid back as a percentage of credit card transactions. There is no interest rate per se but there is a fixed fee that is required to be paid back.

MCA’s morphed into cash advances over the years where now it is used by companies that don’t have many credit card transactions. Instead of the payback being through a credit processing machine the business will repay the amount borrowed through a daily ACH (automatic withdrawal from the businesses checking account).

Merchant Cash Advance and Cash Advance companies are extremely expensive with interest rates as much as 400% APR. The biggest mistakes the small business owners make with these types of loans are: One, the company they select to work – there are many bad players in this business and Two, thinking that if you pay the borrowed amount off early it will be cheaper, however, regardless of when you pay the cash advances off the payback amount will be the same.

The business loan requirements of a cash advance company are very simple. They will want to see bank statements and they will run a personal credit check. Your personal credit must be 550 or better to be approved for the majority of MCA’s.

Invoice Financing Also Known as Invoice Factoring

Invoice Financing has become the more popular term for Factoring. Factoring has been around for a very long time. Invoice Factoring is when a Factor advances you up to 90% of your creditworthy invoice in exchange for you paying the Factor a fee and interest. Factoring or invoice financing is only done with business to business or business to government transactions so if your company is business to consumer, this option is not likely available to your business.

There are two key advantages to Invoice Financing: First, is that, in general, you have unlimited financing as long as you have receivables to back it up and the second advantage is that the Factor is less concerned about your personal credit score or your business credit score since they are paid directly from your client.

The disadvantage of invoice financing is that it is very expensive and hard to actually calculate the true interest rate your business pays in the long run. Also, it is challenging to move away from a Factor because your business will often get used to the cash advancements and the factor will file a UCC lien on your business which will not be released until all invoices are paid (no other institution will make a loan while the UCC Lien is in place and while you wait for the last invoice to be paid so the Factor agrees to release the lien your business runs out of money before you can get other financing in place). Lastly, A Factor may not approve all of your invoices for financing because your clients may not have good business credit.

The largest problem in regard to Factoring is that your clients will have to agree to now send payments directly to the Factor instead of you and some clients will have it in their contract that they will not allow invoice financing.

SBA Loans and Covid-19 Disaster Relief Loans

As of this writing, Covid-19 business loans are winding down and some programs are now completed. In some cases, if you have already received a loan due to COVID-19 you may not be able to apply again.

The government SBA loan program (small business Administration)  prior to COVID-19 is still available but what you should know is the SBA loan program still goes through authorized banks and banks will use the same criteria to approve your business. There may be more leeway when it comes to required collateral and credit score but in general, the underwriting guideline that banks use to underwrite a loan directly will be applied to SBA loans.

The difference with an SBA loan is that the government takes a percentage of the risk if you default on the loan thus allowing the bank to be a little more flexible with some of the requirements.

Business Loan Requirements For an SBA Loan

Startups looking for a new business loan are going to be disappointed to know that there are no companies, banks, or alternative lenders that will provide new business financing. And if you do find one, you will find the fees so astronomical that you will want to run for the hills.

If you have personal collateral to put against the business loan then almost all banks will approve your loan.

However, there is a lot to building a business and it takes years to get paying clients, building internal processes, and learn your niche. Don’t use the excuse of not having money to start a business and in fact, it is a good thing that new business loans are not easily available.

Learning how to build your business using existing cash flow is a good thing. The discipline required for a new business owner will increase their chances of building a successful business that will last.

Friends and Family Business Loans

Many businesses begin with a gift from a family member and other businesses begin with no money at all. But if you are receiving any type of business loan from a family or friend make it official. Let the party know your business plan and why you believe in it and do everyone a favor, let someone who has actually built a GOOD business themselves give you comments about the business plan and ask them for an honest assessment.

Every new business owner thinks that their idea is special but what mostly happens with new businesses is that you get into business with one idea and then you learn something while in business and slightly pivot towards another business plan. That’s isn’t a bad thing and we all know there are inherent risks when building a business.

The true risks of building a business are often smaller then what you are told but vary widely based on your chosen industry. Retail businesses have the highest failure rate but there are many other industries where the chances of success are much higher. Being a good business owner is understanding the risks and mitigating them the best you can to improve the chances of your success.

If you are thinking of taking money from a friend or family try to use that money as a last resort. Personal relationships are much more important than your business success and borrowing money from someone you love causes all types of conflicts that can ruin your relationship.

Loan Approval Processes in General for Traditional lenders

It all comes down to this. The more collateral you have and the better your personal credit score the better financing options you will have. The old adage is that it takes money to make money is very apparent in the banking world. However, don’t be discouraged. You can still start that business and those who use the excuse of not having money to start a business may not have what it takes to build a business.

Building a business takes the ability to work around problems and throughout the life cycle of every business, cash will always be an issue. Knowing the various financing options discussed above and what your business needs is what being a business owner is all about.

Make sure you read this whole article because it has tons of information about business financing that, even if it doesn’t help you now, will help you as your business grows.