Small Business Loans 101: Finding the Right Lender (Part 1)
Searching for a business loan can seem like a daunting task. With so many lenders out there, it’s hard to know what kind of loan you need, where you should apply, and which lenders will actually accept your application.
The search for an appropriate business loan will always be a relatively time consuming process, because you want to find a product that is a good fit for your business. However, if you’re educated about what to look for, you can significantly speed up the process.
Here’s everything you need to know to get started on your loan search, from what lenders are looking for, to the different types of loan products available, to common reasons businesses can’t get a business loan.
What Are Lenders Looking For?
All lenders look for four different characteristics when deciding if they can grant funds to your business. These four, easily discerned characteristics can quickly tell a lender whether or not your business may be eligible for funding.
Here is what lenders are looking for:
Personal Credit Score
Your personal credit score is a measure of how well you’ve repaid your debts in the past. Lenders want to be sure that you, the business owner, have a history of repaying debts in a timely manner. After all, if you have a history of responsibly repaying debts, you’ll likely continue to do so in the future.
Time in Business
The longer your business has survived, the more likely it is to do so in the future. Before granting your business capital, lenders what to be sure that your business has withstood the test of time.
Loans with longer term length often require a longer time in business.
Quite simply, your business has to be making enough money to repay the debt. The amount of revenue you’re currently making determines the maximum loan size you will be eligible for—often lenders won’t let you borrow more than 10% – 15% of your annual revenue.
Debt Service Coverage Ratio
Your debt service coverage ratio (DSCR) basically tells your lender (and yourself) how much money you have available to repay additional debt or make periodic loan payments. According to Investopedia, your DSCR is calculated using this equation:
Net Operating Income / Total Debt Service = DSCR
A DSCR above one means that you are making enough money to cover your current debts, and you could manage more debt without problem. Usually, lenders like to see that you have a DSCR of 1.15 or above.
Which Loans Are You Eligible For?
All lenders have different minimum requirements regarding your personal credit score, time in business, and annual revenue, but most follow specific trends depending upon the product they offer. Use these general standards to decide which loan products you should apply for:
|Credit Score||Time in Business||Annual Revenue|
|Bank or SBA Loan||640||2 years||$50K|
|Medium Term Loan||600||1 year||$100K|
|Short Term Loan||500||3 months||$60K|
|Merchant Cash Advance||500||3 months||$60K|
|Online Line of Credit||600||6 months||$60K|
|Personal Loan for Business||640||n/a||n/a|
It’s important to note that each lender is has their own requirements, which may be more or less strict than the standards written above. However, the above table can help you narrow down your search to loan products you’re more likely to be eligible for.
Looking for requirements for a specific business? Most lenders have their minimum qualifications written on their website, and their customer service reps are often willing to help determine if you’re eligible. We also note the borrower qualifications on our business loan reviews.
Loan Products Overview
Confused by what all the information above means? Here’s a rundown of each product.
Bank, Credit Union, and SBA Loans
Many banks and credit unions offer business loans and lines of credit to eligible merchants. Most banks have very long and detailed applications, but they’re worth it to get the best rates and longest term lengths.
The Small Business Administration (SBA) is a good resource for merchants who can’t qualify for a bank loan on their own. Rather than issuing loans, the SBA backs a portion of your loan, so your business isn’t as risky, and matches you with one of their partner lending institutions.
Medium Term Loan
Medium term loans are installment loans that range from about three to five years in length. These loans are normally offered by online lenders.
Because the term lengths are shorter (and therefore less of a risk), medium-term loans are are normally easier to obtain for than bank loans. But you still have to have an established business (at least a year or two old) to qualify.
Short Term Loan
Short term loans are loans that range from three months to two years. Often, these loans carry a one time flat fee instead of an interest rate, which means you’ll know the total cost of the loan before borrowing. Repayments are often made in daily or weekly installments.
Merchant Cash Advance
Technically, merchant cash advances (MCA) are not loans—they’re sales of future receivables. These “purchases” are collected by deducting a portion of your sales each day. Although they have no set term lengths, most MCAs are structured to be repaid over the course of three months to two years.
Lines of Credit
Lines of credit function similarly to credit cards—you are given access to a certain amount of money, you can draw up to your limit whenever you want, and you only have to pay interest on the amount you’ve borrowed. This type of financing is excellent for businesses that frequently need to borrow small amounts of capital.
Lines of credit are offered by many lenders—both online and through banks.
Personal Loan for Business
Merchants in the earliest stage of starting a business often don’t have access to a whole lot of capital. If you’re unable to continue bootstrapping and/or have exhausted the bank of family-and-friends, you could consider getting a personal loan for business.
Because personal loans are based on your individual creditworthiness, not that of your business, these loans are attainable, even if you don’t yet have enough profits or time in business.
Loan Acceptance Troubleshooting
Even if you meet a lender’s qualifications for your credit score, time in business, revenue, and DSCR, upon further scrutiny, lenders might find other reasons they can’t fund your business.
If your business has any of the following problems, your search for a loan may be more difficult, but often not impossible.
Your Business Isn’t Profitable
Any lender that issues loans for a long period of time, normally above three years, will want to ensure that your business is profitable (or will be soon). After all, your business cannot survive long if it never becomes profitable. Many lenders don’t want to risk their investment on a business that doesn’t yet have a profitable business model.
Not-yet-profitable businesses still have funding options, however. Shoot for lenders that offer loans with term lengths of three years or less—short term lenders, merchant cash advances, some online lines of credit, or even invoice financing, equipment financing, or business credit cards may still work for your situation.
Your Business Credit is Poor
Banks, credit unions, and the SBA look at your business’s history of creditworthiness, along with your own personal score. If you have especially poor business credit, you may want to avoid these institutions until you can improve your scores.
You Have a History of Bankruptcies
Lenders are in serious danger of losing their investment if you declare bankruptcy. Therefore, if you’ve had to declare bankruptcy in the past, you might have difficulty accessing financing until you have a proven track record of running a sustainable business since then.
Businesses that have declared bankruptcy in the past three years will have a very difficult time accessing financing. After that time period, options will open up again.
You Have Tax Liens
Some lenders are not willing to work with businesses that have outstanding tax liens. If your business has a tax lien, be honest and up-front about the situation with the lender you’re working with, and they’ll let you know if it’s a problem.
You Have Outstanding Loans or Other Debt
Many reputable lenders don’t want to play second fiddle to other debtors, even if you have the ability to repay all the debt.
In part, this is because if you pledge collateral in the form of a lien (often a blanket lien) or a personal guarantee, the first lender you borrowed from has primary dibs on your stuff if your business defaults on your debt.
It should be noted that the practice of taking out multiple business loans is known as stacking. While there are legitimate reasons to stack loans, it should normally be avoided, as the practice endangers your business and your lender’s investment.
If you’re having trouble getting financing because of outstanding loans, consider waiting until you’ve paid off the your outstanding debt to take on more, or use a new loan to refinance your old debt.
Finding the right business loan is much like dating: each party is getting to know the other in an attempt to decide whether or not they’re a good fit. Much like dating, too, the search for the right small business loan can be a daunting, long, and occasionally frustrating task.
With the information above, however, your courtship should go a little easier.
What to know what to expect once you’ve found a lender? Check back next week for part 2 of our Small Business Loans series: The Application Process.