The Challenge of Getting a Small Business Loan

Coronavirus has disrupted the economy, shuttered businesses, and cause major uncertainty for small business owners. For some, it’s been easy to move their business online or continue fulfilling and shipping orders. For others, sales might have dropped, and you need working capital to pay rent.

After the announcement of additional funding for Small Business Administration loans, many small business owners thought that it would be easier to access capital. But while the program has more funding, loan qualification requirements haven’t been relaxed. Lenders will still need proof of income, tax returns, and more to approve your loan application.

Small business loans are a tool that can enable a small business owner to keep their doors open during a crisis, fund expansion, or support growth. Even if you don’t have a current need to borrow, you might in the future. Educating yourself about small business lending support successful borrowing.

Small Business Loan Requirements

Requirements vary by lender, with Small Business Administration or SBA loans having the strictest standards. With the exception of the disaster loans they offer, SBA loans are issued through approved lenders. The government backs a portion of the loan, which reduces the lender’s risk. Therefore, lenders charge lower interest rates on these loans.

SBA lenders prefer to work with businesses that have been in operation for at least two years. They rarely lend to small business owners with a credit score below 650. The average size of a small business loan from a larger bank is $493,000, so if you need a smaller size loan, try a smaller bank where the average loan size is $146,000.

Alternative lenders have much lower lending standards, but you’ll pay exorbitantly higher rates. Small business owners with credit scores as low as 500 can qualify, and they’ll lend if you’ve only been in business for two months.  Minimum revenues required vary, but typically start at $5,000 and up. They may want to be repaid daily by deductions from credit card sales or by automatically debiting your bank account.

A small business loan from an alternative lender will have rates between 12% to 45%. Some could charge prepayment penalties if you pay off the loan early. While they are a good option if you need quick access to capital and don’t meet more strongest borrowing requirements, this form of capital is quite expensive.

Documents Required to Apply for a Small Business Loan

Lenders tend to request the same core set of documents, most of which prove your business’s viability and revenue streams. This is the basic list, but a lender could always request more;

•   Last two year’s tax returns

•   Certified financial statements

•   A robust business plan

•   Statement of how you intend to use the funds

•   W-2’s and 1099’s as well as proof of any other forms of income

•   Investment account statements

An accountant must prepare and sign off on certified financial statements. Banks require this because it reduces the risk of misstatement, whether intentional or accidental. If you have investment accounts, personal or business, they could seek recourse from these accounts if you defaulted. Therefore, they’ll request to see statements with these account balances.

When you take out a small business loan, you may have to sign a personal guarantee. This gives the lender the right to go after personal assets - such as your house or car - if you do not comply with the loan’s terms.

If you are applying for an asset-backed loan - such as an equipment financing loan to buy a new forklift - the bank will request documents relating to the asset. These loans can be easier to get because the asset serves as collateral for the loan. If you default, the lender seizes the equipment and can recoup more of their losses.

Because of this, the collateral’s value matters, and the lender will likely request an appraisal. For large value equipment, they may order their own appraisal. When you apply, have any documentation that supports its value ready to provide the bank.

Improving your Odds of Getting Approved for a Small Business Loan

The easiest way to improve your approval odds is to know if you even qualify for the loan. If applying for an SBA Disaster Recovery loan, check to see if your governor has applied for the program already. Governors must first submit to have their state or an area in their state included in the program.

If your governor has applied and the SBA has issued a disaster declaration for your area, take a look at your financial situation and credit score. Be honest about how well you meet the lender’s requirements - if they will not lend to someone with a credit score below 650 and your score is 550, you would just be wasting your time to apply.

If you do meet a bank or other lender’s standards, you can further improve your approval odds by being prepared when you apply. Gather all the required documents before submitting your application. Banks have been swamped under loan applications since the government announced additional funding for the SBA, and if a mortgage broker has to call you back and request more information it delays funding.

What if you don’t have certified financial statements or a business plan? Meet with your accountant, either in-person or virtually, and have them prepare these documents before you apply.

Other Funding Sources

What if you can’t get a small business loan? 

You could consider taking on a business partner in exchange for an investment in your business, but make sure that you choose a partner who shares your vision for the business’s future. When you give up equity, you give up some of your say in how your business is run. 

Before jumping into a partnership, map out a long-term strategy. Try to find a partner who can contribute more than financially to the business, and have an exit plan for when it’s time to dissolve the partnership.

Credit cards are also an option, though they charge rates comparable to an alternative lender. Existing credit cards and lines of credit might not have limits high enough to meet your needs, but they could help during a temporary financial crunch.

Lastly, borrowing from friends and family or crowdsourcing funding is also an option. There’s likely a limit to the financial resources of your network, particularly during a recession. As well, it’s likely only a network you can tap once.

Bring in the Experts 

Before signing a small business loan agreement, talk to your accountant about how payments, upfront fees, and interest charges will impact your cash flow in both the short and long term. Successful borrowing won’t harm your ability to stay in business but will help you continue to reach your goals.