Applying for a business loan for your small business is a big step that can seem intimidating. Having a good understanding of the process and what lenders look for will make navigating the application process a lot easier. The first step that you will need to determine is what type of debt financing works best for your company. Traditional bank loans usually have the best rates and terms, but are harder to qualify for. Alternative lenders offer quicker financing with an easier application process, but with higher rates and tougher terms.
- Required Documents for Small Business Loan
- Evaluation Criteria to Prepare For
What Documents Are Needed for a Small Business Loan
In recent years, the availability of loans from alternative lenders has made the application process much easier. Most alternative lenders have online applications that can be completed under an hour and do not require many documents. Traditional banks and credit unions, however, still require many business and personal documents for their extensive evaluation process (though some banks, such as Wells Fargo, have recently launched online loan applications). Here’s a look at the minimum that is typically required when applying:
|Alternative Lender||Traditional Banks|
*Business plans typically include industry analysis, target market and projected financial information such as profit/loss, cash flow and balance sheets
In addition to the documents mentioned above, you may also need to gather legal documents just in case your bank needs additional information. These documents can include items such as articles of incorporation, partnership agreements, franchise agreements, business licenses, commercial leases and any title documents if property is being used as collateral to secure the loan.
Evaluation Criteria to Prepare For
While there is no standard set of criteria when evaluating an applicant for a loan, both alternative lenders and traditional banks will be looking at the company’s ability to pay back the loan in a timely manner. With that in mind, lenders will look at numerous factors that we have split up into three main categories: general information, business information and financial information.
As part of the application process, lenders will ask for your Social Security Number and your company’s tax identification number. Even though many alternative lenders do not require that you provide them with credit reports as some traditional banks do, both alternative lenders and traditional banks will pull your personal and business credit reports and score. They may also pull your previous personal and business tax returns as well.
Traditional banks will also look at your resume and see whether you have any formal education in the industry that you’re hoping to enter into or expand in. Just like applying for any job, you should have someone take a look at your resume for formatting and typos in addition to substance.
Both types of lenders will be looking closely at how much you are requesting versus your company’s financial health. Make sure that you are not asking for an amount that is too small that you cannot adequately reach your goals, while also making sure you’re not asking for amount too large that you may not qualify for the loan. Generally, a good starting point would be an amount that is approximately 10% of your company’s annual revenue.
Lenders will also want to know what you plan to use the loan proceeds for. You’re more likely to be approved for a loan used to buy necessary equipment or real estate than to pay back other debt or buy non-essential items. Since traditional banks will want a business plan that forecasts projected earnings, it is important to demonstrate a strong understanding of your industry and market. Highlight what makes you competitive in this industry and why you believe you will be profitable. A well-thought-out business plan supported by financial projections will demonstrate that you have a strong business mind and have done your research.
Lenders will be looking at your company’s financial information to determine its ability to pay back the loan on a timely basis. Lenders look at what is known as a company’s debt-to-income (DTI) ratio. This figure is expressed as a percentage and is determined by dividing the total recurring monthly debt by gross monthly income. Most traditional banks will want personal and business DTIs to be below 33-35%.
Whether lenders only look at your bank statements or want more detailed financial statements, it is important to have clear and accurate accounting practices. Traditional banks will want strong revenue, cash flow and profitability. One tool used to measure your ability to repay is the debt service coverage ratio (DSCR). Most traditional banks will look for a DSCR of at least 1.1, but more typically 1.25 and above (anything under 1 denotes negative cash flow). To determine your company’s DSCR, you will first need to calculate your company’s net operating income (also usually available from your company’s income statement), then divide it by the total debt service.
Net Operating Income = Operating Revenue – Operating Expenses
Total Debt Service = Proposed Annual Loan Payments
DSCR = Net Operating Income ÷ Total Debt Service
As mentioned above, lenders will be looking at your personal and business credit history and credit score. Traditional banks will usually want applicants with scores between 700-800, while alternative lenders can work with applicants with scores of approximately 650 and up (though some online lenders may require a credit score as low as 500 or have no minimum credit score requirements). Make sure you pull your personal and business credit reports to make sure that there are no errors in your credit history that need to be fixed.
If time or financial history is an issue, an alternative lender may be your best bet. If time isn’t an issue, make sure to shop around and allow yourself enough time to get the best loan.