With the influx of many new online and other non-traditional lenders, not only are there more options than ever before for a small business owner seeking capital, this new breed of lender is pulling back the curtain and shedding new light on different types of qualifying criteria for a small business loan.
If you’ve ever wanted to know what some lenders are looking for and why they seem to want to dive so deep into your personal finances and your business, here are some of the ways they look at you and your business, along with the reasons why:
1. Personal credit score
While your personal credit score doesn’t really say anything about your business, it remains an important factor in securing business credit. As a small business owner, the benefit of maintaining a good personal credit score will probably never go away. Lenders look at your personal credit history as a measure of your past credit performance and your willingness to meet your financial obligations. There’s a difference between can you repay a loan and will you repay a loan. Your personal credit score is one way many lenders predict whether or not you will.
The good news is that different lenders have different personal credit thresholds they’ll accept. If your score is below 680, you’ll likely not have any success at the local bank, and if your score is below 650, an SBA loan probably isn’t in your future either. However, many online lenders will accept a lower credit score, provided other metrics are in place. Nevertheless, if you have a less-than-perfect credit score, making efforts to improve your score often results in more options, better terms, higher approval rates and lower interest rates.
Experian, Equifax, and Transunion are the three major personal credit-reporting bureaus.
2. Your business credit profile
Unlike your personal credit score, your business credit profile speaks directly to how you meet your business obligations. Dunn & Bradstreet, Experian, and Equifax create profiles and scores based upon how timely you pay your vendors, how current you are with your business credit card payments and how you pay your other business-related bills. It also includes the type of industry you’re in and how other businesses like yours perform over time.
In addition to lenders evaluating your business for a small business loan, potential suppliers can also look at this score to determine your “willingness” to make timely payments and whether or not they should offer you 30-day terms or other vendor credit.
Predicting the future requires looking into the past. This can be problematic for new businesses that haven’t been around long enough to build a business credit profile. If that describes your business, you can start by establishing business credit in places like Staples or Home Depot that offer many of the supplies most small businesses regularly use and they regularly report to the business credit bureaus so your good payment history can help you build a good credit profile.
3. Time in business
Depending upon the lender, the criteria could be a year or less up to several years in business. Some business owners might ask, “Why does how long I’ve been in business make a difference?” The short answer is, lenders are a pretty risk-averse bunch and lending to small businesses carries risk—the younger the business, the greater the risk. Particularly when you consider the statistic that roughly half of the small businesses that start today won’t be around to celebrate their fifth birthday.
Time in business speaks to a track record that can be measured and evaluated. The longer you’ve been in business, the more a lender will be able to measure whether or not you “can” and have met your business financial obligations.
4. Annual revenues
This is another way a lender measures whether or not you’ll be “able” to repay a loan. If a business has no revenue, how is its owner going to make regular and timely payments? Unlike an equity investor, who invests in a business for a cash event in the future, a lender is expecting a regular payment. They want to validate that you can make the first payment—and every subsequent payment.
5. Cash flow and bank statements
In addition to annual revenues, some lenders want to look at your monthly bank statements to evaluate your cash flow. In addition to the traditional monthly payment terms most of us are familiar with, some lenders offer weekly or even daily repayment terms. How cash flows in and out of your business could impact your ability to meet payment obligations.
For example, weekly or daily payment terms require more frequent transactions and deposits than monthly repayment terms and the nature of your cash flow could influence whether or not some types of business loans are available to you. That’s why some lenders want to see your bank statements; they want to verify that you have the right type of cash flow to meet the loan terms.
6. Loan purpose
There are a number of reasons a potential lender would like to know the loan purpose. Knowing the loan purpose helps the lender identify the type of loan that would be a good fit—or if other loan products would be a better fit. For example, there are specific loans designed to purchase equipment, buy a franchise, or purchase commercial real estate.
Loan purpose can also help identify whether a long-term or short-term loan would meet your needs. In the same way most of us wouldn’t consider purchasing a new car with a 30-year mortgage, some loan types are more appropriate for purchasing inventory than heavy construction equipment.
Additionally, some loan purposes eliminate loan options. An SBA 7(a) loan can’t be used to consolidate debt or pay off an existing loan, for instance.
While some lenders approach collateral differently than others, collateral helps mitigate risk for the lender. A small business loan secured with collateral (something of value) allows a lender to recoup some of their losses should a borrower default. Traditional lenders like banks often secure a small business loan with collateral like equipment or real estate. And, while the SBA doesn’t always require a loan to be 100 percent collateralized, they often require all the collateral a borrower might have.
In addition to verifying that you can repay a loan and that you will repay a loan, lenders also want to know what will happen should something go wrong and you can’t make your loan payments. In addition to requiring a little personal skin in the came, collateral gives lenders options in the event you can’t continue to make payments.
While some closed-door decision making still takes place with some lenders, the new landscape of small business lending has pulled back the curtain and is shining more light on how small business loan decisions are made—making it easier for the borrower who does his or her homework to avoid wasting time with lenders who are unlikely to approve their loan request. It also helps small business owners better prepare for the questions they’ll likely be asked when they sit across the desk or talk over the phone with a loan officer.
As the process continues to become clearer and easier to understand, borrowers will be able to access more of the capital they need to fuel growth and fund working capital needs.
I'm a Main Street business evangelist and marketing veteran with over 25 years in the trenches, and write about small business financing as an employee at OnDeck. I try to make the maze of small business finance accessible by weaving personal experiences and other anecdotes into a regular discussion around one of the biggest challenges facing small business today. The opinions expressed are my own and not those of OnDeck.