Taking out a business loan—whether to cover payroll or purchase inventory—can provide financing to help in difficult times, improve your cash flow or grow your business. While each lender has its own rules, there are common business loan requirements you should be aware of when preparing to apply
1. Business & Personal Credit Scores
When you submit a business loan application, a lender will typically review both your personal and business credit scores to assess the risk you pose. While a bad personal credit score can hurt your chances of approval, a good personal credit score can improve your loan approval odds and help you secure a lower interest rate.
What’s considered a good or bad personal credit score varies according to the credit scoring model a lender uses and its own guidelines. One of the most widely used credit scoring models—FICO—ranges from 300 to 850. While scores below 580 are considered bad, a score of at least 670 is considered good.
Although minimum credit score requirements vary, some online lenders may approve you for a business loan with a personal credit score as low as 500. A traditional lender like a bank may require you to have a minimum score as high as 680, however.
Similar to personal credit scores, what’s deemed a good or bad business credit score also varies based on the credit scoring model a lender uses. One of the most popular business credit scoring models—Dun & Bradstreet (D&B) PAYDEX—ranges from 0 to 100. A good score ranges from 80 to 100; a bad business credit score ranges from 0 to 49.
2. Annual Business Revenue & Profit
Lenders often have minimum annual revenue requirements, and some have minimum monthly revenue requirements, too. To confirm your business’ earnings, a lender will request your business’ bank statements and income tax returns. You can upload your bank statements manually or allow a lender to connect to your bank and analyze your statements, if available.
In addition, some lenders may ask to see your profit and loss statements to determine if you have enough positive cash flow to afford your loan.
3. Time in Business
Businesses that have been in operation for longer have a greater chance of loan approval. While minimum time requirements vary, it’s common for traditional lenders to require you to have at least two years in business. Online lenders often require applicants to be in business for at least six months to a year.
However, this requirement may vary depending on the specific type of business financing. For example, with invoice factoring, which involves selling unpaid invoices to a factoring company, a lender may require that you’ve been in business only for three months.
4. Debt-to-income Ratio
Some lenders will review your debt-to-income (DTI) ratio to determine whether you can afford to take on additional debt. Your DTI ratio weighs your monthly debt against your gross income.
You can calculate the DTI ratio by dividing your monthly debt by your gross income. For example, if your monthly debt is $10,000 and the gross income is $20,000, your DTI ratio is 50% ($10,000/$20,000).
The higher your DTI ratio, the greater your risk is as a potential borrower. While minimum DTI requirements vary by lender, it’s a good idea to keep your DTI ratio at or below 43%.
5. Debt-service Coverage Ratio
Another ratio some lenders consider is the debt-service coverage ratio (DSCR), which measures your business’ annual net operating income in relation to its total annual debt. Remember, annual net operating income is another way to say earnings before interest, taxes, deductions and amortization (EBITDA).
To calculate your DSCR, divide your business’ EBITDA by its total annual debt. For instance, if EBITDA is $100,000 and its total annual debt (including the business loan you’re applying for) is $80,000, the DSCR is 1.25 ($100,000/$80,000). A ratio greater than 1 shows a lender your business will likely have enough income available after expenses.
Although DSCR requirements vary by lender, U.S. Small Business Administration (SBA) loans require a minimum DSCR of 1.15.
6. Collateral for Secured Loans
Lenders offer both unsecured and secured business loans. If you apply for a secured loan, lenders require you to pledge collateral—something of value, such as accounts receivable or real estate—that they can seize if you fail to repay the loan.
The collateral requirements can vary, depending on your specific loan. For instance, you could take out a loan to purchase a business asset—like equipment, a business vehicle or commercial real estate. The collateral in that scenario would be the asset purchased. This means if you purchase equipment such as a commercial printer, the printer will serve as collateral.
In addition, some lenders will require you to provide a personal guarantee, which means you accept responsibility for repaying the loan with your personal assets if the business fails to do so.
7. Your Industry Matters
The industry you operate in also plays a factor in whether you qualify for a loan. That’s because each industry has a different risk factor and some lenders are restricted from working with certain industries, such as adult entertainment businesses, gambling businesses and not-for-profit businesses. Before you apply, contact the lender to check your industry’s eligibility.
8. Business Plan
Some lenders may require you to share your business plan, especially if you’re a startup, which may include the following:
- Financial projections
- Purpose of using the funds
- Industry outlook
- Competitive analysis
Your plan should provide a lender with a detailed outline of how you intend to use the loan funds and include a five-year forecast of cash flow, income and expenses. If you’re unsure how to write a business plan, you can find sample business plans on the SBA’s website.
Documents Commonly Required for Business Loans
Before you apply for a small business loan, gather the required documents. A lender will likely ask for some or all of these items:
- Bank statements
- Personal and business tax returns
- Business licenses and permits
- Employee Identification Number (EIN)
- Proof of collateral
- Balance sheet
- Copy of your commercial lease
- Disclosure of other debt
- Accounts payable and accounts receivable ageing
- Ownership and affiliations
- Legal contracts and agreements
- Your driver’s license
- Business insurance plans
- Payroll records
- Incorporation documents
- Business plan
To get a list of all required documents, review your lender’s website and/or contact them before applying.
Next Steps: Decide What Type of Business Financing You Need
The next step after learning how to qualify for a business line of credit or loan is to find the right type of business loan for your unique needs. Some common types of small business loans include term loans, SBA loans, business lines of credit invoice factoring, working capital loans and equipment financing.