Guide To Business Loan Requirements

Small Business Loan Requirements Five ‘C’s

Many lenders consider the Five ‘C’s (or a variation of them) when evaluating a potential small business owner for a business loan:

1. Character:

This is a subjective measure that addresses your reputation and the reputation of your small business. Although this is a very important measure, many bankers ignore, or minimize the value, of this ‘C’ in favor of the other more tangible metrics.

2. Credit Score:

One of the most important of the Five ‘C’s, every lender will look at your credit score when they evaluate you for a potential loan. Business owners of a young company will likely need to show their personal credit score as well as their business score (and yes, there are two scores). Depending on the lender, they all have a score threshold they will not go below. For example, the threshold for a bank is often significantly higher than that of an alternative lender—say 680 instead of 550.

3. Capacity:

This ‘C’ is particularly challenging for early-stage companies and start-ups. It’s difficult for anyone to offer a small business owner a loan if there’s no clear evidence they have the capacity to repay the loan.

Most lenders will evaluate your ability by comparing your annual revenue against your recurring debt. Nobody wants to see you default on a loan, which is why an early-stage or idea-stage company with no product on the market to sell and no income has such a tough time securing financing.

Time in business is another common metric lenders use to measure capacity. Lenders will start considering applicants with a time in business of at least six months.

4. Capital:

Most lenders want to see some skin in the game, which is the capital in this ‘C’. A significant financial contribution by the small business borrower lessons the likelihood of default.

5. Collateral:

Most of the time collateral is in the form of either property or larger assets like equipment. Collateral is one of the most important ‘C’s, which is why we’re talking about it today.

If we consider collateral in the context of a commercial real estate loan, it’s easy to wrap our heads around it. The collateral for the loan is the property we intend to purchase. If the small business owns real estate and needs a small business loan, in much the same way a homeowner would leverage the equity in their home to fund a second mortgage, a small business owner can leverage the equity in any property owned by the business to collateralize a small business loan.

The same is true with regards to an equipment loan. The equipment acts as collateral.

Many alternative lenders weigh the ‘C’ of collateral as more relevant than some of the other ‘C’s. Which is why some small business owners who wouldn’t qualify based upon their credit score are able to get a loan based upon other criteria. An MCA loan, for example, uses the volume of a merchant’s credit card transactions as collateral. A factor, uses a small business’ accounts receivable as collateral. Next to credit score, the fifth ‘C’, collateral, is probably the biggest influencer regarding whether or not you’re able to successfully get a small business loan.

All five are important, but minimizing the value of collateral is a sure way to make sure you hear “no” at the bank. The right collateral is a great way to ensure  a lender says, “yes.”

7 Questions to Prep for Small Business Financing

Why Do You Need Financing?

First, ask yourself if you need financing at all. Could you manage with existing cash flow, or do you really need the extra boost for the expansion you’d like to invest in? It’s better to get a loan before you need it, so think about whether or not you’ll need it in the near future.

If you decide that your current cash flow will not be enough, identify why you need more capital. Are you expanding? Is it for your startup?

What will the Capital be Used For?

Lenders will want to know specifics. Are you investing in new equipment? Hiring more employees? Expanding or upgrading your office space? Don’t leave anything out. Specify what it will be used for with corresponding dollar amounts.

You’ll also want to articulate why you need these improvements? How will these investments grow your business? 

When Do You Need Financing?

If you need a loan tomorrow, you’re probably already too late. Don’t wait for a crisis to apply for small business financing of any kind. Look ahead and plan for growth and protection from crises.

How Much Do You Need?

This is where you’ll really need to get into the details. If you’re looking for startup loans, it’s difficult to know if your financial forecasting is accurate. Many entrepreneurial experts say it costs twice as much as you expected when it comes to startups.

If you’ve been in business for a few years or more, you should have a financial record that will give you a better idea of what you can expect to borrow.

What is Your Repayment Plan?

There should be two parts to your answer:

1. What is your preferred repayment plan (which will then be negotiated)?
2. What if Repayment Plan A falls through? What if your sales are worse than projected? What’s Plan B?

Lenders want to see a realistic vision of how the invested capital will expand and grow your bottom line so that, ultimately, they receive repayment.

How Healthy is Your Personal/Business Financial Status?

Your personal credit is just as important as your small business’s credit–especially if you’re a startup. If your business is young, lenders will want to see your personal credit as well. And, depending on the lender and the type/amount of loan you’re looking for, lenders will likely want to see your personal credit even if you’ve been in business for years.

What are the Qualifications/Capabilities of Your Management Team?

It takes more than money to grow a successful business. If your team is under-qualified or experiencing any kind of dysfunction, you’ll want to take this into consideration when you think about the risks of taking on debt. Make sure your team is qualified and has the resume to impress lenders.

7 Common Documents Lenders Want to See

1. Personal & business credit reports: Lenders want to get an overall picture of your credit health. If you were a lender, would you want to hand out money to someone or some business with a low credit report? Your personal credit says just as much about your financial capabilities as does your business credit report.
2. Income tax returns from previous 3 years: The more profitable your small business looks on tax returns, the more likely it is that you’ll get small business financing. This means that you might want to avoid taking all those deductions for a few years. Oftentimes there’s a tradeoff: write-off deductions and save money during tax season, or pay a hefty tax in order to portray a more profitable company.
3. Financial Statements & Projected Financial Statements (Balance Sheet: assets, liabilities and net worth): Make sure your financial statements are 100 percent accurate. Don’t try to fudge anything here. Lenders will do a number crunch, and if you’ve manipulated anything in any way, their ratios will reveal your dishonesty. Tell it straight. Do your due diligence with the projected financial statements as well. Take the time here to impress lenders with a well thought out and meticulous plan.
4. Personal & Business Bank Statements: Most lenders want to see both personal and business bank statements. You’ll want to be ready to explain any drastic periods where you were low on cash or even went negative.
5. Business license and registration: Luckily, most of this is online if you haven’t kept a physical copy handy.
6. Articles of Incorporation: These are those legal documents you may have not looked over in a while. It’s a good time for you to review the articles of incorporation if you’re looking for financing.
7. Business Plan (Executive Summary, Market Analysis, Company Profile, Organization Description, etc): Make sure you write and edit your business plan. Find other experts and professionals to read through it and find holes before lenders fine them. You want to make sure you’ve covered everything that lenders could possibly ask.

Preparing to Get a Loan

Here is some specific preparation you’ll want to make before you start looking for a loan. Some of this will likely seem pretty obvious, but there might be a few surprises. Most of this advice is the result of speaking to lenders, hard lessons learned by experience, and conversation about this topic with my colleagues.

1. Learn the vocabulary — Like every industry, financial services generally and lenders in particular, have a jargon unique to what they do. You’ll want to understand the difference between simple and compounding interest, what are accrued assets, and what does amortization mean to name just a few. You don’t need to be an expert, by any means. But you will want to be familiar with the basic terminology the loan officer will be using. What’s more, if they use a term you’re unfamiliar with, speak up. Any reputable small business lender will want to ensure that you understand exactly what you’re doing. I spoke with a borrower a while ago who didn’t completely understand the terms of a short-term loan and found himself in trouble at the end of the term. Make sure you understand every word.
2. This is business, but it’s also personal — For most small business owners, your business financial statements aren’t going to be enough. Lenders will also want to see your personal financial statements too. You’ll want to include tax returns, accounts payable and receivable, along with your aging payroll reports. Don’t take for granted that your most recent tax return or P&L will be sufficient either, you should be prepared to talk about at least the last three or four years (if you’ve been in business that long). You should also know that most traditional lenders, like a bank, will want to see a history of at least two years; and even alternative lenders will want to see at least a year. With that in mind, even if your business doesn’t do much or any revenue in the first year or two, it is in your best interest to start keeping financial records as soon as you start doing business to demonstrate how long you’ve been in business rather than how long you’ve been generating revenue.
3. Can you talk about industry averages? — They may have different risk tolerances, but I’ve never met a lender who wanted to throw good money after bad. They tend to shy away from troubled industries—unless you can show them how what you are doing is more successful than industry trends. There are some industries though, that are appealing to some lenders over others. If you can determine which lenders specialize in your industry, your odds of success greatly improve. Most industry groups supply this kind of information to their members, which would likely help you build a stronger case. Remember, anything you can do to make lending to your business appear less risky makes it more likely you’ll get the financing you need.
4. Have your elevator pitch dialed in — Many lenders are going to want to learn more about your business. I’m surprised at how many business owners can’t articulate very well what they do. One of the exercises I think helps is writing a page, a paragraph, and a sentence about your business. You’ll likely go through several drafts, but start with the page. Take the entire page to describe what you do and why it’s relevant to the market. When you’re done with that, tackle the paragraph. If  you’re like most people, it will be more challenging than the page. Once you feel good about that, tackle the sentence—which will be the most difficult. Once you’ve completed this exercise, you’ll be ready to tell people about what you do any time you’re asked. It’s a good idea to keep these documents as reference and maybe even include them within the information you’re going to share with the lender.
5. Share your roster — When you think about how your business is really the sum total of the experience of your leadership team and their ability to execute a well-reasoned plan, you’ll understand why the lender may be interested in that experience. Not all lenders are interested in that level of detail, but the bank certainly is, and the act of collecting all that information will give you the confidence to extol the virtues of your management team at a level most business owners can’t. This is more information you will want to include with the information you give the bank.
6. What other pies do you have your fingers in? — If you have a business interest in any other business, you’ll want to make sure you have that information available too. This also includes any of your key leadership.
7. What’s the plan? — This is the one thing every lender I ever speak with says they wish more small business owners would provide. Why are you seeking a loan? What are you going to do with the proceeds from the loan? What positive impact do you expect to see from the extra cash? What are your contingency plans should something not work out as planned? This is something that should be casually put together either, it should be a formalized document that demonstrates that you’ve given this more thought that a conversation with your business partner at the diner down the street. In reality, this is a critical part of your sales pitch and you should treat it that way. It doesn’t have to be a PowerPoint presentation, but I don’t think it would hurt. It does need to be a formal document of some kind that outlines your answers to the questions above.

You’re probably more qualified for a small business loan than you think you are. Just take a deep breath, fill out our 15-minute application, and explore your options.