Are you in need of funding for your business but feeling anxious about applying for a small business loan? It's understandable.
With talk of recession in the air, lenders become more risk-averse and reluctant to lend money. And with interest rates on the rise, there's more pressure on small business owners to repay their loans. So applying for a loan can be nerve-wracking — especially if you don’t know what lenders expect from you or what gets their attention when they review applications.
To help you overcome that hurdle, here are five practical strategies that can help boost your chances of securing a small business loan.
Review your business plan
Lenders want to see that you have a solid plan for how you’ll operate and grow your business, so a business plan is a crucial part of the loan application process.
A comprehensive and well-thought-out business plan outlines your company's objectives and the strategies you intend to use to meet them. It should include an overview of your business, a market analysis, financial projections, details about management and personnel structure and other relevant information.
If it’s been a while since you updated your business plan, take the time to review and update it with current information before starting the loan application process. It can be a lengthy document with many supporting schedules and other materials, so you don’t want to scramble to throw it together at the last minute.
Check and improve your business and personal credit scores
Having good credit is essential if you want to get approved for a small business loan with an affordable interest rate. So before applying, pull your business and personal credit scores and see if there’s any room for improvement.
You can access small business credit scores through Experian, Equifax or Dun & Bradstreet. Ideally, your business credit score will be 80 or above, putting you in the “low-risk” category.
You can request a copy of your personal credit report once a year from AnnualCreditReport.com. Many credit card companies and lenders are also now including personal credit scores on their customers’ monthly statements, so look at a recent paper statement or log into your account online.
A personal credit score of 720 or above will help you qualify for the best rates.
If your scores are not up to par, consider taking steps to improve them by:
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Making all of your monthly payments on time
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Paying down your credit card and other debt balances
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Asking for higher credit limits
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Disputing any errors on your credit report that might be dragging your score down
Get your documents ready
Applying for a small business loan usually requires submitting a variety of documents. Getting these documents together ahead of time can help you sail through the application process and get your loan approved much faster.
While business loan requirements vary from lender to lender, this list is a good starting point:
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A copy of your business plan
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Personal and business financial statements
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One year’s worth of statements for your business and personal accounts
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Business and personal tax returns for the past three years
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Your business’s articles of incorporation or operating agreement
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A list of business owners, their equity stake in the small company and their resumes
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Current accounts receivable and accounts payable aging reports
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A copy of your business license and any significant contracts with customers or suppliers
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Franchise agreements (if applicable)
Get ready to provide proof of cash flow
Cash flow is an essential consideration for lenders when approving small business loans. Your cash flow indicates your ability to repay the loan and keep the proverbial lights on, so lenders want to ensure you have adequate cash flow before agreeing to lend you money.
In addition to checking your cash flow statement in your financial statements and cash flow projections in your business plan, many lenders will calculate your debt service coverage ratio (DSCR) when deciding whether to approve your loan application. They calculate the DSCR by dividing your business’s net operating income by your total debt service.
Net operating income is your business’s revenue minus operating expenses before deducting interest, depreciation and amortization. Debt service is the amount you pay each year toward all debts, including principal, interest and lease payments.
For example, say your net operating income for the year is $150,000. You’re currently paying $1,000 per month ($12,000 per year) on an equipment loan and want to take out a loan that would have monthly payments of $2,000 ($24,000 per year). Your debt service coverage ratio would be:
$150,000 / ($12,000 + $24,000) = 4.17
Lenders prefer to work with borrowers with a debt service coverage ratio greater than 1.25, so with a DSCR of 4.17, you’re well-positioned to get approved.
Find the best lender for you and your business
Different lenders have different criteria when it comes to small business loans. So it’s important to do your research and understand which lenders are likely to approve your application and what they'll look at before agreeing to lend you money.
In addition to traditional banks and credit unions, consider looking into small business loans from alternative lenders, such as fintech companies or peer-to-peer lenders. They often offer small business loans with more flexible terms and conditions than traditional banking options.
Don’t just settle for the first small business lender you come across. Interest rates, fees and repayment terms can vary widely from lender to lender, so it pays to shop around and compare small business loan options to find one that fits your needs.
By following these steps, you’ll be prepared for the small business loan application process and ensure that your small business loan application is in the best possible shape before it goes to lenders. Good luck!