Learning how to apply for a business loan can feel overwhelming, but with the right information and documentation, you can secure the funding you need while making a confident and informed decision.
In this article, we’ll detail the requirements for a business loan, share how and where to apply, and provide accounting tips to help after you’ve been funded.
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They’re designed to back businesses “on the margin” that normally wouldn’t qualify for bank loans.
Get Our SBA Loan Application GuideHow Hard Is It to Get a Business Loan?
You might be wondering how hard it is to get a business loan. The answer depends on several factors, including your business’s financial health, credit score, and the type of loan you’re seeking.
The strictest requirements can be difficult for new companies. For example, Bank of America’s minimum requirements for a $25,000 loan require two years in business, $100,000 in gross revenue, and a 700 FICO score.
The only way to discover how much funding you qualify for is to submit an application. Many institutions can provide an estimate with only a credit check and revenue estimate, but a formal submission will be required for a hard figure.
| Warning: Be aware lenders run personal credit checks when you apply for funding. FICO advises the impact of a single credit check is usually less than five points, but multiple inquiries increase the effect. |
Business Loan Requirements
Options for business loans range anywhere from millions of dollars from traditional banks to tens of thousands from personal credit cards. The following are the most important criteria lenders will look for when you apply. A solid application that clearly outlines these aspects will improve the rates and terms you’re offered.
- Gross Revenue: Depending on the loan, the funding available will often be a proportion of your gross sales. For example, a reasonable bank may extend a line of credit up to 20% of annual revenue.
- Personal Income: Banks often require personal guarantees to secure business loans, and appreciable personal income is an asset.
- Credit Score: Unsurprisingly, a high credit score is important for lenders considering applications. Most consider a good score to be 700 or higher.
- Collateral: Company-owned real estate, inventory, equipment, and even accounts receivable can all serve as collateral for a business loan. If that isn’t enough, banks may also allow you to use your home or personal investment assets.
- Debt to Income Ratio: There’s no hard and fast rule for a “good” debt to income ratio, but you’ll be well positioned if your business is financially solvent and you carry no personal debt on your credit cards.
- Years in Business: The longer you’ve been in business, the better your odds of securing financing. At least a year is good, but banks often look for two years or more.
- Overall Risk of Industry: Some industries are easier to get loans for than others. For example, technology startups can be risky because they often lack tangible assets for collateral. The failure rate in the restaurant industry is quite high, leading banks to be hesitant to extend capital.
Documents Required for a Business Loan
Securing a business loan requires various documents providing a comprehensive picture of your business’s financial health, creditworthiness, and operational details. While they can be challenging to collect and organize, doing so improves your chances of success.
| Commingling business and personal funds can disqualify your application; properly tracking business expenses is key to presenting clear revenue and cash-flow figures to lenders. Related: What to Do if You’re Commingling Funds |
Here is a list of common documents you might need:
- Business Plan: Lenders can’t be an expert in every industry. A well-crafted business plan can help them better understand your company’s purpose and demonstrate your expertise.
- Financial Statements: A balance sheet, income statement, and cash flow statement provide a snapshot of your business’s financial health.
- Financial Projections: When you ask for a specific sum of money, it’s important to justify why you’ve chosen that amount. Well-crafted financial projections estimating costs and future cash flows lend credibility to your application.
- Tax Returns: Whether they’re personal or business tax returns, these will verify your income and financial history. Having two to three years on hand for your application is recommended.
- Bank Statements: The bank will use these to verify your cash and revenue flows. They’ll want six to twelve months of statements; remember, it’s important that these are free from commingled personal and business funds.
- Collateral Documentation: If you’re using real estate or other assets to secure your loan, the bank will want to see proof of ownership.
- Accounts Receivable: Banks often accept promises of future cash flow as collateral for large loans; documentation such as signed contracts and past payments is helpful.
- Articles of Incorporation: These documents prove you’re operating as an official business entity, such as an LLC or S-Corp, rather than a simple sole proprietorship.
- Proof of Identity: The bank will ask for a photo ID in conjunction with your application.
If you’re considering a business loan, contact us for a free consultation; our Fractional CFO services team has decades of experience guiding companies through fundraising.
Types of Business Loans
Various loan options are available, each tailored to different business needs and financial situations. Once you’ve applied, a banker can walk you through their available financial products.
Here’s a breakdown of what might be available:
Business Loans Without Collateral: Business loans without collateral are based on the borrower’s creditworthiness and the business’s overall financial health. Since they’re unsecured, they often come with higher interest rates and lower borrowing limits than secured loans.
Secured Business Loans: Conversely, secured loans offer lower interest rates and more funds in exchange for equipment, property, or other assets a lendee posts as collateral.
Fixed-Rate Loans: Loans with interest rates that remain constant for the entire term of the loan.
Variable-Rate Loans: These instruments feature interest rates that fluctuate over the loan term. Rates are often set as a function of the prime interest rate, which The Federal Reserve influences.
Balloon Loans: Small regular payments and a large “balloon” payment at the end.
Revolving Credit: Accounts that can be drawn on repeatedly, up to a limit, as long as payments are made. They function similarly to credit cards, except business owners can withdraw cash from them.
Interest-Only Loans: Borrowers only pay the interest for some or all of the term, with the principal balance due at the end.
Bridge Loans: Short-term financing to cover immediate needs until a long-term solution is secured.
Business Loans vs. Personal Loans
Unfortunately for business owners, banks require personal guarantees on most loans, regardless of their purpose or terms.
Nevertheless, some companies are offered financing without personal guarantees from owners. To increase your chances of securing a business loan without a personal guarantee, organize your company as an LLC rather than a sole proprietorship, and read our guide to building business credit
Where to Apply for a Loan
Getting a loan isn’t easy, but luckily for business owners, there are a number of avenues they can take. Terms will vary, but no matter your revenue, credit score, or collateral, a loan product is probably available to you.
Traditional Banks: Established institutions often offer the most favorable terms but have the strictest requirements. Even if you don’t qualify for the best options, a banker can help with an SBA loan application or refer you to alternative lending options.
Credit Unions: Since they’re smaller than name-brand institutions, they sometimes compete for loans by offering more flexible lending criteria. If your credit is questionable or you have little collateral available, this can be an appealing option.
Online Lenders: These companies often have the fastest approval and funding processes but also carry the least favorable rates. If you pursue this option, be sure to carefully research reviews; creditors in this space can be dishonest about their offerings.
Community Development Financial Institutions (CDFIs): Providers in this sector specialize in lending to underserved populations and economic revitalization projects in low-income communities. If your business is unappealing to traditional lenders, a CDFI may be a good option.
| Tip: Establishing a relationship with a bank is incredibly valuable. For example, many companies missed out on Covid relief funding because they lacked a professional guide. A banker who knows your name will be motivated to support you in any way they can. |
What to Do After Your Loan Is Approved
Having your small business loan funded is an exciting time. While you should certainly celebrate, it’s also time to get down to business and use your funds effectively.
Officially Register the Loan With Your Business Entity
Just because the bank required a personal guarantee this time doesn’t mean they will in the future. Building your business’s credit score makes future funding opportunities less likely to require them.
Your business credit score, like your personal credit score, will improve based on responsible behavior. This helps with your eligibility to borrow more money at lower rates and potentially without having to use personal credit in the future.
Maintain an Emergency Cash Reserve
It’s good to be prepared for the unexpected. Maybe a client pays an invoice late, or a shipment costs more than you expected. Keeping 3 – 6 months of operating cash flow liquid can help you cover last-minute emergencies and ensure you make your loan payments on time.
Consider Repaying Early
This decision requires a cost-benefit analysis. If you’ve invested the funds profitably and are making a healthy return, it can be worth reinvesting the surplus or holding on to the money to maintain cash reserves. On the other hand, you could save on interest by repaying early.
Keep in mind that while early repayment may boost your credit score, some loans carry pre-payment penalties.
Account for Cash Flow Effectively
One difference between new and experienced entrepreneurs is how thoroughly they know their financials. A simple spreadsheet may have sufficed to begin with, but as your business grows, a more sophisticated bookkeeping plan becomes important.
Automated bookkeeping software is a must for growing businesses. It saves time, minimizes human error, and accurate accounting is key to maximizing tax deductions.
Additionally, a fractional CFO can help you put together a three-statement financial model, combining cash flow, balance sheet, and income statements into a single, easy-to-read dashboard. If you’d like help visualizing your finances like this, contact us for a consultation today.
Frequently Asked Business Loan Questions
In our nearly fifteen years of experience, we’ve discovered a handful of questions that are especially common for those seeking business loans.
Here are answers from our experts.
What Credit Score Do I Need to Get a Business Loan?
The market for business loans offers a diverse set of lenders, each catering to different financial situations. The tradeoff for entrepreneurs is they’ll pay higher interest rates in exchange for lower credit scores.
According to Lending Tree, traditional banks prefer FICO scores of 740 or higher, while alternative lenders offer loans down to ~500. SBA loans operate in the middle, advising would-be borrowers to aim for scores of 680 or higher.
How Long Does It Take to Get a Business Loan?
For traditional bank lending, the time from application to funding can take up to 90 days, regardless of product or sum of money. For non-traditional lenders, the process can take less than a week or even days, but the terms are usually less favorable.
Does a Business Loan Affect Personal Credit?
Yes and no.
When you submit formal documentation for a loan, lenders will run a “hard” credit check which lowers your score slightly. However, lenders will also run “soft” credit checks during initial screenings that don’t impact your score.
Your lending institution should notify you of any hard credit checks before they are run.
Conclusion
Applying for a business loan might seem daunting, but with the right preparation, you can navigate the process smoothly. By understanding the essential requirements, gathering the necessary documents, and selecting the best type of loan for your business needs, you can secure the funding you need to grow.
