A Comprehensive Guide to Business Loan Requirements
- Lenders may ask for different types of documents during the application process. Some of the requirements that business owners need to meet may also vary on the specific loan type.
- However, there are still several requirements and eligibility criteria that most lenders still have in common. It’s important to be aware of the core credentials when applying for a business loan.
- Business owners applying for loans must always consult prospective lenders regarding their specific application processes. This will allow them to gather all necessary documents or prepare all the information they need to submit.
- Aside from preparing all necessary documents, those who intend to apply for a business loan must also ensure that they follow the protocols when submitting their applications. Committing mistakes may delay the funding process, or worse, cause lenders to reject the application outright.
Business loans can provide various benefits to almost any type of business. Aside from providing additional funding for day-to-day operations, they can also help fund major business projects. Business loans can help quickly expand a business and fuel its growth, which can then lead to more profits and possible long-term success.
They may also be used to gain immediate access to additional funds without selling a percentage of the company. Not all business owners are comfortable with receiving additional funding from investors. Though investors may provide enough funding to help a business grow, they also expect to not only have a say in the business’s general direction but also to have a share in its profits.
These are some of the many reasons why many business owners turn instead to business loans. The main thing is that borrowers can use the money however they want while having the freedom to run their business according to their plans. With a business loan, no other entrepreneurs will interfere with decisions. Business owners also don’t need to consider the opinions of other shareholders.
This is why many business owners opt for business loans over any other type of financing. Research shows that in 2017, as much as 40% of American business owners applied for a loan. About $600 billion dollars were borrowed during that year.
This number became higher in 2020 as more than 90% of businesses in the US lost revenue during COVID. This led to over $782 billion borrowed by various businesses, mostly through the payment protection program.
What business owners should note, however, is that lenders may ask for different types of documents during the application process. Some of the requirements that business owners need to meet may vary based on the lender or the specific loan type. For example, bank loan requirements may be more stringent, while online lenders may only ask for a few business loan requirements.
However, there are still several requirements and eligibility criteria that most lenders still have in common. Though it’s important to note that not all lenders will require all of the business loan requirements listed below, most will ask for the same core credentials. These include the borrower’s personal and business credit scores, as well as the business’s annual revenue and the number of years it has been operating.
Different Types of Business Loan Requirements
Since lenders may ask for various types of requirements other than the core criteria, it’s best that business owners know the different requirements that may be asked of them. Here are 20 of the most common ones that lenders scrutinize:
1. Number of Years in Operation
Before providing funds, most lenders will want to know how long a business has been in operation. The longer a business has been operating, the higher its chances become for getting approved for a loan. This is because a business that has been operating for quite some time can better prove that it has had long-term success.
Typically, the minimum that lenders ask for is at least two years. However, it doesn’t mean that a business under two years old automatically becomes disqualified for a business loan. It just means that it may have to be strong in other qualification criteria. It may also mean that the business may instead look for alternative lending options.
For example, most banks are unlikely to provide loans to businesses under two years old. However, online lenders usually have more flexible requirements and may provide loans to newer businesses.
2. The Business Owner’s Personal Credit Score
Lenders look at a borrower’s personal credit history and financial information so they can better assess the likelihood that the loan will be repaid.
Business owners who have a strong financial history and credit scores tend to handle finances well. This may then translate to the business and its cash flows may also be properly handled.
It’s also good to keep in mind that personal credit scores don’t just determine whether or not the loan will be approved. It also plays a role in determining the loan interest rate as well as the types of loans that may be available.
The better the personal credit score is, the more loan options that will be available to the potential borrower. A credit score of at 600 or higher is what will qualify for a bank or SBA loan.
3. The Business’s Credit Score
Just like how a personal credit score can indicate someone’s history as a borrower, a business credit score can also be used to assess a business’s creditworthiness. This is based on a business’s history of payments made to its suppliers and lenders. Also taken into consideration are the business’s size, industry, and revenue.
This is why all entrepreneurs need to ensure to get a good business credit score. Aside from it being a common small business loan requirement, it is also a part of the FICO SBSS. The FICO SBSS stands for Small Business Scoring Service, a business credit score determined by both a borrower’s personal and business financial habits. The FICO SBSS is commonly used to evaluate loan applications.
It’s also important to note that there are three main agencies that track business credit. These are Dun & Bradstreet, Equifax, and Experian, and each has its own method for evaluating business credit scores.
Lenders usually use a combination of different scoring methods to evaluate applications. It’s important, however, for a business owner to always maintain a positive business credit score regardless of the way a lender evaluates a potential borrower.
4. Annual Business Revenue and Profit
A business’s annual revenue and profits is also a common small business loan requirement. Lenders typically ask to see both a year-to-date profit and loss statement that has been updated within the last 60 days, as well as statements from the previous two years. This is because most lenders will want to ensure that a business is profitable before granting loan approval. On the other hand, alternative lenders may not require profitability but instead have a minimum annual revenue as requirement.
Regardless of a specific lender’s requirements, however, it’s always good to be able to show strong business financials. Good annual revenue and profits lead to better chances of being able to qualify for financing. It may also lead to business financing options with more affordable rates.
5. Loan Purpose
Business owners also may need to describe how they plan to use the funds, if ever their loan becomes approved. Loan purpose statements need to be as specific as possible, as lenders may want to check if the loan amount being requested is in line with the loan purpose,
6. Loan Amount
Since lenders check both the loan purpose and the loan amount, potential borrowers must also be specific about how much they intend to borrow and ensure that it matches up with the purpose stated.
A borrower who needs higher loan amounts may turn to banks, as they have more access to capital. Most can issue loans going up to six and even seven figures. However, business owners who only need smaller loan amounts (usually below $250,000), may instead opt for alternative lending options. There are also SBA loans that provide smaller figures.
For a business loan to be approved, the potential borrow must be clear and direct about how much money is needed, and why. It’s also not a good idea to ask for too much that what is really needed.
7. Tax Returns
Lenders may also ask for both personal and business tax returns. Similar to personal and business credit scores, lenders usually need tax returns to evaluate both a borrower’s personal and business financial standings. This gives them a better overview if the loan can indeed be repaid.
Most lenders ask for at least personal tax returns from the past two years. Personal tax returns become even more important for those who have pass-through entities, which include a sole proprietorship, partnership, or S-corporations.
Business tax returns, on the other hand, are especially important for those who have a corporation, or even an LLC that is taxed as a corporation. If this is the case, then lenders usually ask to see business tax returns from the last two years in order to verify the business’s revenue, profit, and expenses.
8. Bank Statements
Bank statements are often used by lenders in order to determine whether or not the business can afford the loan amount being applied for, and if there are high chances that the loan will be repaid. Bank statements can also help provide lenders insight into how well a business’s cash flow is managed.
Lenders typically ask for at least the last four months of a business’s bank statements. This is for them to be able to check if if the claims made about the company’s financial history are well-supported. However, it’s good to note that those applying for conventional bank loans may be asked to provide more bank statements, as these types of loans usually also provide larger loan amounts. Those applying for SBA loans may also be asked for additional statements as borrowers need to not only qualify for the lender’s qualification, but also for for the Small Business Association’s stringent criteria.
9. An Updated Business Plan
A business plan or loan proposal is usually not part of the requirements for most small business loans. However, longer-term traditional loans and SBA loans are more stringent, and may therefore ask entrepreneurs for their updated business plan or loan proposal.
These documents provide borrowers the opportunity to lay out both their qualitative business goals as well as their financial goals, which can include future sales, income, profits, and cash flow. These also allow borrowers to prove to lenders that they have thought about all the potential opportunities and challenges that the business may come across. It also provides a roadmap as to how the business can become more successful in the near future, which can then better assure lenders that the loan will be repaid.
10. Entity Type
Some lenders may also ask business owners to report their business entity type. A business can be a sole proprietorship, where it is just run by one person (who then also benefits fully from the business). Sole proprietors may include professionals, service providers, and retailers. Usually, a sole proprietorship isn’t considered a separate legal entity from the business owner. However, it is considered a separate entity for accounting purposes.
A business can also either be a general or limited partnership. A general partnership is an agreement between two or more persons to run a business, and each partner contributes money, assets, or skills. Each one also shares in the profits and losses of the business. A limited partnership, on the other hand, limits the personal liability of individual partners depending on the amount they have invested.
A business can also be a limited liability company, or an LLC. This is somewhat like a hybrid of a partnership and a corporation. Members of an LLC may be granted the operational flexibility and income benefits of a partnership but also have limited exposure to liabilities.
Another entity type is a corporation, wherein the business can exist as a separate legal entity. However, articles of incorporation must be filed so that stockholders can be protected from liability.
Lastly, a business can be a small business corporation, or S-corporation. S-corporations limit the number of its members and usually have a better tax advantage.
Most lender need to know how business is organized so that they can better evaluate how well the business is managed. Also, some lenders don’t provide loans to sole proprietorships and partnerships. Most prefer lending to LLCs and corporations because these types of businesses have more legal protections, which make them less likely in case the business owner faces a lawsuit or any type of financial setback.
11. Business Licenses and Permits
Other lenders may want to check a business’s license or permit. Though these may vary depending on the state and locality, some lenders may want to check not only for a business’s license to operate but also for additional proof of ownership.
Depending on the business’s size, location, and industry, some lenders may also ask for additional documents as proof. These may be fire permits, zoning permissions, environmental permits, and health department permits.
A business’s industry type may directly affect its business loan eligibility. This is because each industry has a different level of risk, which lenders may take into consideration.
Most lenders also don’t provide loans to businesses in certain industries, such as those in the firearms business or those related to adult entertainment. This is because lending to such businesses can negatively impact the lender’s reputation. However, some lenders also restrict lending to other industries for their own reasons. For example, some don’t provide loans to law offices, childcare businesses, apparel companies, health care businesses, and other financial companies.
This is why business owners need to make sure that they have correctly identified their business’s industry in the loan application, after ensuring that the lender does provide loans to the industry that the business is in. Business owners also need to be careful when filling out applications, as a small mistake regarding the business industry can lead to processing delays, or worse, cause a lender to mistakenly reject the application.
13. Proof of Collateral
Not all types of loans may require collateral. Those that do, however, may ask business owners to put up a fixed asset such as real estate property or expensive equipment in order to secure the loan. If the borrower ends up defaulting on the loan, the lender can then seize the collateral to make up for the money lost. This is why collaterals can help lenders mitigate risk, especially with larger loan amounts or longer-term lengths.
Though not all lenders ask for collateral, those that do may want to know the type of collateral that a business may offer, as well as the value of that collateral. For example, this is usually common when applying for an SBA loan.
Those that don’t require physical collateral, such as alternative lenders, may instead ask for additional security other ways, such as a personal guarantee or a blanket lien.
14. Balance Sheet
There are many lenders who ask to see a business’s balance sheet before approving a loan application. This is because similar to a profit and loss statement, a balance sheet can help a lender gain insight into how a business functions and whether or not it is in good financial health.
Lenders may want to see a business’s balance sheet to check whether it has enough assets to cover its operating expenses during the loan period. This can also be used to see if the loan can be paid back in full and on schedule.
This is why business owners should have their year-to-date balance sheets prepared, as well as their balance sheets from the previous two years, if applicable.
15. A Copy of the Commercial Lease
If the business has a physical store, then the business owner should prepare a copy of the commercial lease along with other commercial loan documents. This is because lenders may want to verify if the business will be able to use the property for the entire lease duration. This became additional assurance that the business will be able to operate during the loan’s term length, and therefore, increases the chances that the loan may be paid in full.
16. Employer Identification Number
Not many lenders ask for an employer identification number (EIN) for business loan applications. However, it’s a good idea to specify the EIN on a loan application, if there is one.
The EIN is a unique, nine-digit number that is can be regarded as a social security number for businesses. The Internal Revenue Service (IRS) uses the EIN to track business to track a business’s tax returns.
A business owner can easily apply for an EIN online. Though not many lenders require an EIN, it may be a good idea for a business owner to apply for one, regardless.
17. Business Debt Schedule or Disclosure of Other Debt
Some small business lenders may be wary of providing loans to business owners who already have outstanding debt. This is because they may think that offering additional financing may lead to the business owner not being able to meet all the loan payment schedules.
This is why some lenders ask potential borrowers to provide a business debt schedule when applying for loans. However, another good way to determine whether business owners can afford a loan is to calculate their debt-service coverage ratio.
The debt-service coverage ratio (DSCR) can apply not only to business owners, but also to corporate and government entities. It measures if the available cash flow is enough to pay for all current debt obligations. It shows how a business owner’s current debt and interest payments are in relation to the incoming cash flow.
If a business owner’s DSCR isn’t high enough, then a lender may reject the loan application. The lender may also ask the business owner to instead reapply after all existing debt has been paid.
18. Disclosure of Ownership and Other Affiliations
Business owners applying for a loan may also need to disclose any ownership that they or their partners may have in other businesses. This also includes any other affiliations such as being a consultant or board member in other businesses.
This allows lenders to better gauge if there are any potential conflicts of interest after the loan has been issued. It also allows them to gauge any synergies that the business may have with other companies.
Potential borrowers should also be aware that it can be more difficult to be approved for a loan if a business has multiple owners. This is because different lenders may set their own rules regarding the number of owners that a business may have.
For example, the SBA asks for documents pertaining to the personal financial information of anyone who owns more than 20% of a business applying for a loan. They also ask for a personal guarantee from all of the business owners. On the other hand, other lenders may require approval from only those who own anywhere from 50-70% of the business in question.
It’s also important to note that anyone who needs to authorize the loan may be asked to provide additional documents. These may include a copy of their ID, their resume, personal credit score, as well as documents that the lender may ask for.
19. Accounts Receivable and Payable Aging Reports
When business owners apply for bank loans, they may be asked to subit their current accounts receivable (A/R) and accounts payable (A/P) aging reports. These documents allow the bank to gauge how efficient the business is at receiving payment from their clients, as well as paying their suppliers and contractors.
The A/R report contains the number of overdue invoices that a business needs to collect, as well as how long these invoices have been overdue. If th A/R report shows too many outstanding invoices, then the lender may think that the business isn’t efficient with collecting payments.
On the flipside, an A/R report that only shows a few overdue accounts may mean that it is effective and efficient at repayment collection. Lenders may then feel more secure about providing loans to these business as their clients can quickly pay off their debt.
The A/P report is the opposite of the A/R. It provides the number of invoices from suppliers or contractors that the potential borrower still needs to settle. When there are too many accounts that need to be settled, it means that the business may be a delinquent client and that it has a weak strategy to manage its expenses. This is why businesses need to have a low number of overdue accounts on the A/P report in order to qualify for a bank loan. It’s even better if there are zero overdue accounts.
20. Copies of Legal Contracts and Agreements
The last business loan requirement in this list are copies of legal contracts and agreements that a business already has. In order to better gauge a business’s capacity to pay off a loan, the may ask to see any of the following documents:
- Contracts with their suppliers or other businesses;
- Corporate bylaws that govern how a company is run;
- LLC operating agreement;
- Partnership agreement;
- Franchise agreement;
- If the loan is going to be used to buy another business, then lenders may ask to see sales agreements, financials, and information about the business about to be purchased;
- If the loan is going to be used to purchase commercial real estate, then lenders may ask to see real estate purchase agreements; or
- If the loan is going to be used to purchase equipment, then lenders may ask to see equipment purchase agreements.
Although this list may seem overwhelming, what is important to remember is that different lenders may have different loan requirements. Since business loan requirements widely vary, business owners applying for loans must always consult prospective lenders regarding their specific application processes. This will allow them to gather all necessary documents or prepare all the information they need to submit. The goal is always to optimize the process and increase their chances of getting approved.
Common Mistakes to Avoid When Applying for a Business Loan
Aside from preparing all necessary documents, those who intend to apply for a business loan must also ensure that they follow the protocols when submitting their applications. Committing mistakes may delay the funding process, or worse, cause lenders to reject the application outright.
Here are some of the most common mistakes when applying for a business loan, and how to avoid them:
- Submitting documents that are difficult to read.
Some words may be blurred out or some details may be ineligible. Applicants must also watch out for stains that may cause blurriness.
- Being unclear about statements.
Descriptions must also be thorough yet straight to the points. Other statements, such as the purpose of the loan, must always be specific.
- Providing documentation that doesn’t cover the right timelines.
Most lenders will ask for the latest copies of documentation. For example, providing tax returns that only cover some of the years that the lender requests may cause delays in the processing.
- Not providing the right amount of information.
Not having enough details in the application may raise some eyebrows. On the flipside, providing too much information may also be a red flag for lenders.
- Typographical errors and other mistakes.
Applicants must always double-check and proofread all their documents. Errors in providing the industry code or the EIN number can lead to significant delays.
- Missing deadlines.
Applicants must always check their lenders’ timelines and follow them. Most will not process applications that go past the deadline.
- Making major purchases while the application is pending.
Business owners should avoid making expensive purchases while the application is pending, as this may cause the lender to think that obtaining additional funding isn’t necessary.
- Applying major changes while the application is pending.
Business owners should also refrain from applying significant changes to their business operations or structure while the application is pending. Lenders may ask them to update their documents, which will lead to significant delays.
Some of the mistakes listed may seem like simple errors. However, any of them can be significant in the application process. Applicants must take the effort to check and double-check all documents and information provided. Otherwise, they may face problems regarding loan approval.
Another important thing to consider is to avoid making any false claims or statements in any of the documents. It doesn’t matter if a false statement was made knowingly or unknowingly. If an applicant has any doubts about any details included in the application, then it’s best to not submit it and double-check the information, first. Details regarding financials may be consulted with an accountant. Going to a lawyer is a good idea to double-check legal concerns.
Business loans can offer a lot of benefits for any type of business and are often used to gain immediate access to additional funds. Since not all business owners are comfortable with receiving additional funding from investors and many don’t want to sell a percentage of their company to investors, they instead can turn to lenders.
However, potential borrowers need to compare all their options and search for the right business funding solution. For example, banks and SBA loans tend to require the most documentation, as well as the highest qualifications. The upside is that they also usually offer the most desirable rates and terms.
Business owners can also turn to alternative lenders who often have simpler application processes and less stringent qualifications. However, they also generally have shorter terms, lower amounts, and higher interest rates.
What is important is that business owners review all their options and ensure that they meet the qualifications specific to the loan product and the lender they intend to borrow from. When they understand the most common business loan requirements, they’ll be able to gather the necessary documentation. The goal is to always have a speedy and successful loan application process.