Business loans can be essential to launching a startup or expanding an existing company, with funds often used to secure inventory, purchase equipment, rent operational space, hire employees or cover a host of other expenses. However, business loans can be difficult for new companies to get, and the process can also be challenging for existing enterprises. Organizations need to understand not just the different types of loans available and how to apply, but also what is and isn’t likely to make you a candidate for approval by one of the top business loan providers.
Be aware of these eight roadblocks that can keep you from getting approved for a small business loan.
Cash flow, a measure of how much cash you have on hand to pay back a loan, is usually the first thing lenders examine when gauging the health of your business. Insufficient cash flow is a flaw that most lenders can’t afford to overlook. Therefore, it’s the first thing you should consider to determine if you can afford a loan.
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“Really thinking through that cash flow equation is like preventative medicine for your business,” said Jay DesMarteau, senior executive vice president and chief commercial banking officer at Northwest Bank. “You can either wait until your business gets sick, or you can do things to prevent it from getting sick.”
One of the preventive measures DesMarteau recommends is to calculate your cash flow at least quarterly. If you take that step, you may be able to optimize your cash flow before approaching potential lenders.
To figure out how large of a loan payment you can afford, divide your net operating income by your total annual debt to calculate your debt service coverage ratio. You will have a ratio of 1 if your cash flow is equal to your projected monthly loan payments. Though a ratio of 1 is acceptable, lenders prefer a ratio of 1.35, which demonstrates you have a buffer built into your finances.
“If you’re not sure of your current financial position or capacity, sit down with a financial planner to help you gain the perspective you need and create an action plan to address any lacking areas,” said Chad Rixse, director of financial planning and wealth advisor at Forefront Wealth Partners.
Credit reports are one of the tools lenders use to determine a borrower’s credibility. If your credit report shows a lack of past diligence in paying back debts, you might be rejected for a loan.
Paul Steck, COO of Spread Bagelry, has worked with hundreds of small business franchisees, many of whom had bad personal credit as a result of illness, divorce or other extenuating circumstances.
“Sometimes, very good people, for reasons beyond their control, have credit issues, and unfortunately, that’s a real barrier to entry in the world of small business,” said Steck.
It is difficult to qualify for a small business loan with a credit score lower than 700.
“A score of 720 seems to be the magic number, above which your likelihood increases dramatically and below which it decreases dramatically,” said Brian Cairns, founder of ProStrategix Consulting, which provides a host of services to startups and small businesses.
If your score is under 700, Cairns recommends focusing on fixing it if you can. Begin by checking your personal and business credit scores to ensure they are accurate. If you find any errors, correct them before beginning the loan application process. You can order a free personal credit report yearly from each of the three credit-reporting companies on AnnualCreditReport.com or individually from each credit-reporting agency: TransUnion, Equifax and Experian. To check your business credit score, contact Equifax, Experian or Dun & Bradstreet.
Additionally, you should build a strong personal credit score and drive down any debt prior to applying for a business loan.
“The better your personal finances are upfront, the more likely you are to be approved for a good loan option,” said Jared Weitz, founder and CEO of United Capital Source, a lender for small and midsize businesses.
“Most loans require some form of down payment, and this is typically varied based upon the borrower’s financial history and the collateral put up for the loan,” Weitz added. “Based on this, most loans range from zero to 20 percent down payment for the loan.”
If your credit is still far from ideal after trying to improve it, consider nontraditional financing options, which tend to place less emphasis on credit scores, before giving up on getting a loan.
“Angel investors, or individuals interested in backing the business in exchange for a share in the eventual revenue, can be a way to help get your business off the ground,” said financial attorney Leslie Tayne of Tayne Law Group.
Having a plan and sticking to it is much more attractive than spontaneity in the finance world. It also gives you a better chance of getting a business loan.
“Lenders want to see that you have a well-thought-out plan for your business,” Tayne said. “Applying for a loan with no business plan or with a half-baked plan will not bode well.”
It isn’t uncommon for very small businesses not to have a formal business plan, or any plan at all, but you’ll still need to put in the time and work to develop a comprehensive business plan before ever walking into a lender’s office.
“If you don’t have a documented plan in place, with financial information and projections, your chances of receiving the big loan you want will dwindle,” said Weitz.
A standard business plan includes a summary of your company, market, products and financials. If you’re not sure your plan is persuasive enough to sway the lender, consider seeking the advice of a business plan expert who can review it and offer feedback.
You should also be prepared to explain how you plan to use the money you want to borrow.
“Applicants can position themselves much better by being able to call out exactly what they need and what they need it for,” said Bernardo Martinez, a former U.S. managing director for Funding Circle, a small business loan platform, and a current PayPal Ventures advisor.
“Instead of asking for $100,000 in working capital, if an applicant says they need $33,000 for inventory in advance of their busy season, $37,000 for new hires, $20,000 for upgrades to their store and $10,000 for advertising, we are much more confident in their ability to effectively deploy the funds,” Martinez added.
At the bare minimum, loan applicants should be prepared to explain why they want a loan and how they plan to repay it.
Some business owners assume they can cover all their bases by applying for multiple loans at one time. This way, they can pick and choose from a range of potential loan offers. However, submitting too many loan applications at once can be a red flag for credit bureaus.
Although you can apply for too many loans at once, being declined now shouldn’t stop you from applying again in the somewhat-distant future.
Before approaching potential lenders, business owners should have their act together. That means having all the paperwork necessary for your loan application on hand.
“One of the things that can be a problem when applying for a loan is if business owners don’t have the documentation that the bank will require,” Steck said.
Obligatory documentation often includes a detailed business plan and proof of collateral; extensive financial records, such as income tax returns, personal and business bank statements, loan history, and a balance sheet; and legal paperwork, like franchise agreements, business licenses and registrations.
There are many resources that business owners can refer to when putting together their loan applications. The Small Business Administration (SBA), for example, provides a highly detailed loan application checklist for borrowers. Using these resources decreases your likelihood of coming across as disorganized or unprepared.
Careless errors will land your application in the rejected pile. “Filling out the application incorrectly or omitting information is another common mistake that can lead to your application getting denied,” Tayne said.
Tayne also pointed out that sloppy bookkeeping and inconsistent business practices, such as mixing business and personal bills together or not filing tax returns, can prevent you from getting financing. She advises taking the time to gather all the necessary information, fill out the forms completely and read over your application before submitting it.
When you apply for a business loan, lenders want to see that you’ve sought guidance from knowledgeable advisors.
Accountants can be an important source of advice for small business owners, according to Stephen Sheinbaum, CEO of Circadian Funding, which helps small and midsize businesses obtain working capital.
“But there are many other places to find good people to talk to, such as the Service Corps of Retired Executives [SCORE], a free mentoring service that is supported by the Small Business Administration,” he said. SCORE connects you to retired businesspeople with experience in your market. “This is important because they will know about the kind of capital that is most important to people within your industry.”
Sheinbaum also recommends business owners get financial advice from business networking groups and conduct research on the websites of the leading alternative funders since many have detailed resource sections for small businesses about the many kinds of available capital and the best ways to prepare for funding.
Other resources that provide counseling, advice and financial assistance for new businesses include the regional and local offices of the Veterans Business Outreach Center and Women’s Business Center.
Finding a lender can feel so daunting that it might be tempting to sign up with the first one that comes along. But blindly pursuing one loan provider without exploring your other options is a mistake. Take the time to research a variety of traditional and alternative lenders to find the best fit for your business.
Financial institutions in the community where you plan to do business are an ideal place to start looking for a business loan, according to Logan Allec, a CPA and owner of Choice Tax Relief. “Start with a community bank or credit union that is more invested locally, as they may have certain programs to be able to work with new local businesses.”
The SBA also provides federal backing for some businesses to receive loans through partner financial institutions. “This can be an excellent avenue to explore if you are having trouble finding a traditional lender for your business,” Allec said.
Other alternatives to traditional lenders are online lending platforms, peer-to-peer lending sites and even your own network of friends and relatives. If you pursue this last option, Allec suggests working up an official, notarized agreement to avoid any misunderstandings or conflicts down the road between all involved parties.
When shopping around, you can also request that each lender help you calculate the annual percentage rate (APR) of their loan offer.
“The APR tells you the true cost per year of borrowing money; it takes into account your interest rate plus any additional fees and charges,” Martinez said. “This will help you make an apples-to-apples comparison of different loan offers.”
So much of the application process for a business loan is methodical, directed by the orderly presentation of concrete documentation, that it’s easy to forget there is an inherently emotional component to this process as well. Too many business owners simply don’t demonstrate why they, rather than someone else, are a good candidate for a loan. They approach lenders with an apathetic attitude, according to Steck.
In addition to making a sound business case for why you should qualify for a loan, you need to exude enthusiasm and faith in your venture to draw in the lender and make them a believer. To do this, you must tell a story about your business that the lender finds compelling.
“‘I’m going to do this, and I’m going to be the best in the whole wide world.’ You have to go into it with that sort of mentality, and a lot of potential borrowers don’t do that,” Steck said.
Weitz echoed this sentiment. “The more prepared, serious and passionate you appear about your business, the more trust a lender will have with approving you for the loan.”
Depending on your needs, you have many kinds of lending options. Here’s a brief overview of the most common types of business loans.
These small business loans are processed by participating lenders, which are often banks, but because they are guaranteed by the U.S. Small Business Administration, lenders have more confidence in repayment. Even if the borrower defaults on the loan, the lender will still get back up to 85 percent of its money from the government. The maximum loan amount you can receive for an SBA loan is $5 million. SBA loans are desirable for small businesses because the rates and terms are lower and more lenient than those of many other options.
Typically offered by banks and online lenders, short-term loans range from $5,000 to $250,000. They are generally repaid in less than a year. It takes up to two days for borrowers to receive funding from this type of loan. [Read related article: The Pros and Cons of a Term Loan?]
Instead of providing funding for startup costs, long-term loans are meant to help grow established businesses. They are often not fully repaid for several years but have a low monthly interest rate. You can generally secure a long-term loan of up to $100,000 from a bank.
Online or direct alternative lenders are often willing to provide financing options for borrowers with bad credit. With these lenders, your credit score isn’t the determining factor for approval. Instead, they consider your cash flow and recent bank statements to determine your eligibility for a loan. While you can typically be approved quickly, you are likely to face high interest rates and/or brief payback periods.
Secured loans require collateral from the borrower, which can be property, vehicles, equipment, stocks or other assets of value. Banks and credit unions offer secured loans that are often easier for new businesses to get and have lower interest rates than unsecured loans. Loan amounts typically range from $50,000 to $100,000.
Unsecured business loans don’t require collateral, but because this makes the loan riskier for the lender, interest rates are often higher, and borrowers must have a high credit score to qualify. Unsecured loans are usually offered by online lenders, including peer-to-peer lenders, and by banks and credit unions as personal loans.
More loans are secured than unsecured since the former lowers the lender’s risk. Unsecured loans, on the other hand, lower the risk for you, not the lender, so they may be worth putting in the effort to find.
Merchant cash advances are available from dedicated merchant cash advance companies and some credit card processors. It’s a loan against your business’s future earnings that you repay through a percentage of your credit card sales. It is a fast way of securing funding because it doesn’t require collateral, which means a quicker turnaround for approval, but interest rates can be very high. It’s typically used by retail stores or restaurants. Merchant cash advances can range from $5,000 to $500,000, and repayment terms vary between three and 18 months.
[More information on cash advances: Small Business Loan vs. Cash Advance: What’s the Difference?]
Equipment financing, not to be confused with equipment leasing, is a loan from online lenders that you take out to purchase tools or other equipment for your business. It doesn’t require a down payment, which helps you preserve your capital and maintain cash flow. The equipment you buy is considered the collateral for this type of loan, which means that if you default on the loan, the equipment you bought with the funds will be repossessed. Loan terms range from two to 10 years, and amounts range from $100,000 to $2 million.
Invoice factoring is when your company sells its unpaid invoices to a factoring company for cash. This helps you maintain cash flow for your business. The factoring company gets paid once your customers pay their balance. Invoice financing helps you avoid cash shortfalls, but it’s usually more expensive than other types of funding. It also limits the control and communication you have with your clients. For example, you can’t decide how the invoice company collects invoice payments from your customers.
You can typically apply for a business loan online with a digital application. When you apply for small business financing, it’s critical to understand what information small business lenders need from you so you can gather the appropriate documents. Typically, you will need the following documents:
Some lenders will request collateral. As mentioned above, collateral can take many forms (property, vehicles, stocks or any asset of value), but you must understand that if you fail to repay the loan, the lender will keep the assets you pledged.
After you submit your business loan application, depending on the lender and the type of loan, it can take days, weeks or even months to get approved.
Convinced the factors detailed above won’t be an issue for you? If you’re ready to start applying for business loans, dive right in with our picks for the best business loans below.
Taking steps to address your potential funding roadblocks can help your business obtain great loans, whether your company is brand new or established. Working with a business financing expert is always a smart step as well. With their help and a commitment to getting your financial records in order, your dreams of growing your enterprise can become one step closer to reality.
Max Freedman and Paula Fernandes contributed to this article. Source interviews were conducted for a previous version of this article.