What should you know about applying for a loan as a Small Business owner?
Is this your first foray into the world of small business loans? One of the first steps to starting your business is applying for a small business loan. However, sound financial planning is essential to your success.
Before starting the application process, there are a few things that every small business owner should be aware of.
Here are the top five things to be aware of:
They are all unique.
Being organized will aid in approval.
Scams are widespread.
Understand your debt service to coverage ratio.
Be prepared to support your company.
They are all unique
The types of small business owners who apply for loans are just as varied. There are different types of loans available, and not all lending institutions operate in the same way. Each lender has a unique method for determining loan terms. Each will have a different rate and amount to offer, and each will have a different minimum credit score.
Being organized will aid in approval
Take into account approaching the application procedure like you would a job interview rather than just stepping into a bank and winging it. You will speak on behalf of your company and make your case for why the lender should grant you a loan. You must make some preparations for this. You must have a strong business plan and a clear explanation of how you intend to use the funding.
Scams are widespread
Online financing gives more companies access to funding, but it also exposes them to additional danger. You run the danger of becoming a victim of a scam, just like with any other kind of internet business. Make sure you are borrowing from a reputable lender before you sign any online documents. If something seems too good to be true, it probably is, as the saying goes. Remember to read the fine print as well. Companies may find it simple to tuck in extra charges or clauses here.
Understand your debt service to coverage ratio
Your debt service coverage ratio, or DSCR, is something prospective lenders will consider. You may figure out yours by dividing your net operating income by the total debt service, which is the sum of the principle and interest payments you would make. Your DSCR is 2 if your monthly cash flow is $5000 and your loan payment is $2500 because your loan payment is half of your monthly income. The majority of lenders prefer DSCR scores greater than 1.5.
It goes without saying that your chances of getting the loan are better the higher your DSCR.
Be prepared to support your company.
Some lenders prefer to work with business owners who are prepared to use their own assets as collateral for the loan. This not only demonstrates your confidence in your company by putting your assets on the line, but occasionally a company may not have enough collateral to cover the loan amount. You must be willing to put your own finances at risk if you want other people to risk their money on your venture.
Here are three factors that lenders typically consider to determine your loan eligibility:
1. Personal and commercial credit ratings
For a government-backed SBA loan or a small business loan from a typical bank, you'll probably need good personal credit or exceptional business credit. Online lenders could be more forgiving with credit scores, focusing instead on the cash flow and track record of your company.
Your ability to repay personal debts like credit card balances, auto loans, and mortgages is indicated by your personal credit score. A personal credit score is required by small-business lenders because they want to know how you handle debt.
The FICO score ranges from 300 to 850, and is frequently used in loan decisions (the higher, the better).
2. Annual income
Many lenders will only take into account companies that generate a minimal amount of monthly or annual revenue. Depending on the lender, you'll need a different amount of cash flow. For instance, OnDeck, an online lender, requires $100,000 in annual revenue to be eligible for a line of credit, while Bank of America requires a minimum of $250,000.
If your business has little revenue and you need a loan, you'll probably need to turn to alternative financing sources like invoice factoring.
3. Years in operation
You typically need to have been in business for at least two years to be eligible for a business loan from a bank. Online business loans typically have fewer restrictions but still call for at least six months of operation.