Your business needs reasonably priced financing from a responsible lender. You can maximize your chances of success by understanding how lenders approve small businesses for loans. We’ll guide you through everything you need to get accepted for the right loan at the right price.
Understand If Your Business Actually Needs a Loan
We know this might sound a little strange, but the most important question is whether you actually need a loan in the first place. If you need to meet operational expenses or cover day-to-day costs, you may have some better options. For example:
- Dig into your profit and loss and other reports to learn exactly where you’re making and spending money.
- Categorize your business expenses and get insight into your highest costs.
- Negotiate new terms with suppliers, vendors, lenders, or others to reduce monthly costs.
- Diversify into new products and services that can boost revenue.
If you want to expand into new areas, boost your inventory, invest in assets and equipment, refinance existing debt, boost your working capital, or buy real estate, then a loan could be a great choice. In that case, you’ll need to define how you’re going to use the money.
Decide Why Your Small Business Needs the Loan
A lender will want to know exactly how you’re going to use their money. Think carefully about how much you will need and where you’re going to spend it. We believe that the more specific and detailed you can be, the more confidence the lender will have that you’ll use the money wisely. For example:
- If you’re developing new products and services, what is the full cost breakdown for each stage of development?
- If you’re expanding into new countries, territories, and markets, what research shows that there’s a demand for your offerings?
- If you’re investing in real estate, equipment, or other assets, how will that help to reduce costs or drive profitability in your business?
- If you’re increasing your stock levels, can you show how consumer demand is increasing?
Lenders like to see statistics and facts. Back up your claims with cited and verifiable research—this will help you create a stronger loan application.
Calculate How Much Your Small Business Needs to Borrow
You’ve decided why you need the money, now you’ll need to work out how much you should borrow:
- Carry out a complete analysis for your loan.
- Determine how you’ll spend what you borrow.
- Attach a dollar amount to every item.
- Add everything together.
This will give you the total amount of capital that you need from a lender.
Estimate Interest Rates and Loan Durations to Understand Likely Repayments
It’s time to break out the loan calculator. Using your total required capital as a guide, try out various interest rates and repayment durations to see:
- How much you’ll need to repay in capital and interest.
- How long you’ll be making payments for.
- How much each repayment will be.
Make Sure Your Business Can Make Repayments on the Loan
You will need to make any repayments out of your excess cash flow. Look at your profit and loss reports and cash flow statements to understand the maximum you can afford to repay on a monthly basis. Demonstrating the ability to repay is critical to a lender’s decision.
Lenders typically use something called the “Debt Service Coverage Ratio” (DSCR) to see if you can afford to pay back a loan. Here’s how you work it out:
- Work out your average monthly net income (revenue less expenses) over the last year.
- Divide the monthly net income by the monthly loan repayment amount.
- Your average monthly revenue is $15,000 and your average monthly expenses are $12,000.
- Your average monthly net income is $3,000.
- Your monthly loan repayment amount is $1,500.
- $3,000 divided by $1,500 means your DSCR is 2.
Lenders will want you to have a DSCR of at least one—in other words, you have enough net income each month to make the repayment. If your DSCR is below or close to one, you will need to increase it by reducing expenses elsewhere, creating more profit, boosting revenue, or reducing the repayment amount.
Understand Other Factors Lenders Use to Approve Small Business Loans
Your reason for borrowing, amount of capital, and ability to repay aren’t the only factors a lender will use to decide whether to approve your loan. Other areas they will look at include:
- Your total time in business: Lenders prefer to lend to well-established, stable businesses with a proven track record. Most large banks and the Small Business Administration won’t typically lend to businesses that have been around for fewer than two years.
- Annual revenue: Your ability to make repayments is important, but showing that your annual revenue is stable or increasing reassures lenders that you won’t be a financial risk. You’ll have access to most loans if you can show at least $100,000 in annual revenue.
- Personal credit score: Although your business might have its own credit score, lenders will also use your personal credit score to decide if they’re likely to be repaid. The higher your personal credit score, the better.
Here at Connect2Capital, we’ve built a network of specialist lenders that may be able to help even if you don’t meet all of the criteria above. At the minimum, you will need to be current on any existing loan repayments or debt, and not have any derogatory marks on your credit report.
Gather Together the Documents You Will Need to Make a Loan Application
Every lender will have slightly different application requirements, but you should expect to provide the following:
- Basic business information: The name, entity type, address, industry, and other particulars of your business.
- Business plan: This should include a business overview, operations plan, sales and marketing plan, competitive market analysis, product and service overview, financial plan, projections, and a management team summary.
- Personal financial history and credit score: A lender may ask about your credit profile, experience running a business, and your financial position.
- Financial statements: Bank, credit card, and other statements for your business. If you’re already repaying a loan, you will need to include your repayment and debt schedule.
- Business history: You should show how your small business is functioning and whether you’re a startup or an established business.
- Tax returns: Many lenders will want to see your personal and business tax filings.
- Business legal documents: You may need to provide articles of organization, operating agreements, and other business documents.
- Revenue projections: A lender will want to know about your cash flow to decide how much to lend and your repayment terms.
Apply For Your Small Business Loan
You have all the information and documents you need to kick off your application. Go through your lender’s application process carefully, paying attention to all questions, and providing the details they ask for. Remember that you want to show that you’re going to use their money wisely, that you can afford the loan, that you have a good understanding of your business, and that you’re not going to default.
Get that right, and you’re most of the way there.