To get off the ground, most small businesses need financing of some kind. Lenders aren’t handing money out to just anyone. They want to be sure that they will be repaid, and they screen loan applications to limit their exposure to the risk of non-payment. What exactly are lenders analyzing and should you know before seeking a small business loan?
According to the Small Business Administration (SBA), lenders look at the following five areas in determining whether or not a loan applicant qualifies for a loan:
- Can you repay the loan?
- What does your credit history look like?
- Do you have any equity in the business?
- What is securing the loan?
- How much experience do you have in running this business?
Let’s break down each of those areas of concern further, and see how you can address each one.
1. Can you repay the loan?
Yes, banks do want to know that they aren’t just giving money away. So what can you do to demonstrate that you pay them back? A lender will look at whether your business is making any money or whether you have other means to pay the bank back, says the SBA. If yours is a new business, then you will need to provide information to the bank on whether collateral, or some other means, will be used the repay the loan.
2. What does your credit history look like?
If you are even thinking about applying for a loan, you must know what your credit score is. Request a copy of your credit report well in advance of submitting you loan application, recommends the SBA, so that you can review it and request a correction of any errors. If your business has also established credit, be sure to check both your personal and business credit score.
3. Do you have any equity in the business?
The amount of equity will be reflected in the company's balance sheet, and is usually due to either an investment of funds or through earnings that have not been re-invested. The SBA advises that lenders generally prefer that a business debt not exceed four times the amount of equity. Should your balance sheet not reflect this standard, it may be necessary to seek out additional sources of funding.
4. What is securing the loan?
Collateral are assets that can be sold to pay back the loan, and can be pledged by the borrower or a co-signor to the loan. The SBA notes that the value of the collateral is generally discounted.
5. How much experience do you have in running this business?
It will be difficult to obtain a loan without any experience in the line of business for which the loan applicant is seeking a loan. The loan applicant should be able to demonstrate that she or he has experience, or that they are hiring or partnering with people that have experience.
As with anything, preparation is key. Objectively evaluate your loan application, or have someone do it for you. Consider the following questions:
- Have you adequately prepared a business plan, as well as the loan application?
- Where are the weaknesses in your application?
- Have you addressed those weaknesses?
If you haven’t, go back and provide an explanation that addresses the lender’s concerns. For additional information on how to best prepare for your loan application, see the SBA’s article, Business Loans – What Lenders Look For and Tips for Winning Them Over.