When a lender receives a business loan application, it looks at various aspects of your company to determine whether it meets the requirements for a business loan. These criteria may vary slightly depending on the type of loan you’re trying to get. It can also vary from lender to lender.
It’s common, however, for most lenders to review things like your business credit, finances, assets, and collateral in evaluating the risk associated with lending you money. Ultimately, it needs to know that there is a high likelihood that you’ll be able to pay back the funds in a timely manner.
1. Business Characteristics
When a lender conducts its risk assessment of your business, it can consider things like the industry you’re in, how long you’ve been in business, your sales performance, and your overall business outlook.
Lenders can consider industry trends to determine how likely your business is to continue growing. It can also look at the legal implications of the product or service you’re providing. Cannabis, for example, is an industry that many lenders deem ineligible for financing largely due to the fact that it is not currently considered legal at the federal level. Small Business Administration (SBA) loans are another example of a type of loan that may look at the nature of your company’s products and services as part of the loan approval process.
Your company’s location is also commonly a factor that lenders review in determining your eligibility for a loan. Many will require you to operate and earn revenue within the U.S. Others, due to regulatory reasons, may not issue financing in certain states.
The longer your company has been in business, the more favorably you may be viewed by lenders. Startups and other businesses with less than two years’ time in business have a high failure rate, making them a larger risk for lenders. Even if you find lenders willing to issue funding to startups, rates, and fees will typically be higher to offset the increased likelihood of default.
For newer businesses needing funding, see our guide on startup business loans.
A lender may require your business to meet a minimum threshold for revenue. Lenders may also consider the trend of your income, whether it has been increasing, declining, or remaining steady. Businesses that have had a decline in income may still be eligible for financing if their income is still sufficient to pay their debt obligations, although documentation may be needed to determine whether the income has since stabilized or is expected to continue dropping.
A business plan is a document that outlines various aspects of your company. Most business plans include information about your company’s finances, a description of products and services offered, revenue and growth projections, competitor analysis, and marketing strategies.
They can be especially important if you are a startup company seeking financing. Without a long track record of sales, they can give a lender more insight as to why your business will be successful, and why it should lend you money. SBA loans are an example of a loan type that commonly requires a business plan as part of the loan application process.
You can download our business template by heading over to our guide on how to write an SBA business plan.
Lenders must verify that your business is properly registered to conduct business legally. This may involve a review of the following list of documents:
- Business licenses
- Professional certifications
- Copies of your company’s articles of incorporation
- Corporate bylaws
- Franchise agreements
- Partnership agreements
- Limited liability company (LLC) operating agreement
2. Credit & Debt Obligations
Your business and personal credit scores can both be reviewed by a lender as an indicator of how likely you are to continue making payments in a timely manner. Lenders will also consider the amount of debt you’re carrying to see if your income can support an additional loan payment.
A FICO score is the most common personal credit score used by lenders. According to Fair Isaac Corporation, this is the credit score model used by 90% of the top lenders. FICO scores typically range from a low of 300 to a high of 850. Scores are determined based on things like your payment history, amount of debt, length of your credit history, mix of credit, and new credit you’ve obtained.
Lenders often pull data from the three major credit bureaus, e.g., Equifax, Experian, and Transunion, and due to variations in the data kept by each of the bureaus, it’s common for each to produce a different FICO credit score.
Credit scores can generally be categorized as good or bad based on the following scoring bands:
800 to 850
740 to 799
670 to 739
580 to 669
300 to 579
To learn more about how to improve your credit score, check out our article on how to fix bad credit.
The Dun & Bradstreet PAYDEX score is the most commonly used scoring model for business credit. Scores run from a low of zero to a high of 100 and are generally regarded as good or bad based on the following scoring bands:
Dun & Bradstreet PAYDEX Score
80 to 100
50 to 79
0 to 49
Other scoring models include Experian Intelliscore and the FICO Small Business Scoring Service (SBSS), which is sometimes used for SBA loans. Head over to our guide on business credit to learn more about how business credit scores work and how you can improve your score. You can also see our instructions for how to read a business credit report.
While your personal and business credit reports may list a majority of your debt, lenders will still consider other financial obligations that do not appear on a credit report. This is an important step for a lender as it helps it more accurately determine your ability to take on additional debt based on your income.
Some examples of additional debt payments can include:
- Lease payments for your office locations
- Recently obtained loans not yet appearing on credit
- Purchase contracts (equipment, real estate, or other business assets)
- Contracts with other suppliers or vendors
The income generated by your business is a crucial component of its ability to repay a business loan. Based on the type and amount of financing you’re looking for, lenders will determine whether the income you’re earning is sufficient to handle additional loan payments.
Lenders may also evaluate the historical trending of your income. Companies that have had a significant increase in income or have had relatively consistent sales will typically be viewed favorably. Significant drops in income, however, are a cause for concern for many lenders as they’ll want to know why it happened and whether the income has since stabilized.
Commonly requested documents to support your business income can include the following:
- Personal and business tax return
- Profit and loss (P&L) statement
- Balance sheet with information on current liabilities
- Business bank statements
- Business debt schedule
- Accounts receivable (A/R) aging report and accounts payable (A/P) aging report
- Personal financial statement
4. Financial Reserves
Some lenders may require you to have financial reserves as a requirement for getting a loan. This lowers the lender’s risk of issuing you funds as it means you will be less likely to be delinquent on a loan payment in the event of a temporary drop in sales or revenue. Financial reserves may be measured by the number of months of loan payments. Alternatively, some lenders may just require proof of a minimum dollar amount in your business bank account.
Even if not required, pledging collateral for a loan is viewed favorably by lenders. This is because doing so allows the lender to take possession of the collateral in the event of a default, something that can help reduce its financial losses. Some examples of collateral can be equipment, real estate, vehicles, or other personal property.
If collateral is pledged for a loan, your lender will typically need to complete an appraisal to determine its value and condition. These are items that can affect not only your ability to get financing but also the rates and terms that you are offered.
As part of the appraisal process, different factors will be taken into consideration depending on the type of collateral. For example, real estate loans may look at purchase prices of comparable properties that have recently sold, seller concessions, and geographical locations. Vehicle loans, on the other hand, may prioritize things like mileage and model year.
The appraised value of your loan’s collateral will often determine the maximum loan amount you’re eligible to get, and by extension, the down payment you must have. You can make this determination by using our borrowing base calculator, which tells you how much you can potentially borrow based on a lender’s guidelines.
If you have collateral that depreciates quickly, lenders may also utilize a collateral coverage ratio. This ratio takes into account an asset’s decline in value due to normal use and other factors. You can see our guide on the collateral coverage ratio to learn more.
When collateral is being pledged for a loan, lenders will often make use of a UCC filing to create a lien. Liens can be found via public records and serve as a notification to other creditors that another lender has a security interest in the collateral in question. Filing a lien also protects the lender, as ownership cannot be transferred without the loan balance first being paid in full.
You can learn more about this process in our article explaining how UCC liens work.
To protect the collateral being pledged for the loan, lenders will require it to be properly insured. The exact type and amount of coverage will vary based on things like state regulations and the industry you operate in.
Apart from our ultimate guide to small business insurance coverages and costs, you can view our articles below for our insights on a few different types of coverage.
6. Loan Terms
Many loan applications will ask you what type of financing you’re looking for. You can indicate the loan terms you’re seeking, such as a loan amount, payment schedule, payment structure, and loan term. The loan terms you’re looking for can not only impact your loan options but can also impact which lenders can accommodate your request.
Lenders may have certain thresholds for minimum and maximum loan amounts that can be issued. The same is true for loan terms. If the lender you’re seeking financing from does not offer the amount or length of financing you need, check if it’s specific to that loan program or if it’s only a limitation of the lender. Banks and credit unions can often offer a wider range of loan options, but you can also consider business loan brokers and online lenders for alternatives.
The loan amount and repayment term you choose will also impact your approval odds. These are both items that affect your required loan payment amount, and lenders may not issue you financing if they deem the minimum payment to be excessive in relation to your income.
Loans are commonly structured to have payments made monthly. However, some loans may also have daily, weekly, biweekly, or seasonally adjusted payment options.
Loans can also be structured such that payments cover various portions of the principal balance and accrued interest. Some examples include the following:
- Fully amortized loan payments: With a fully amortized loan, each payment covers a portion of the principal balance and accrued interest such that the loan balance will be fully paid off at the end of the loan term.
- Interest-only payments: Interest-only payments on a loan only cover the accrued interest charges. The principal balance of the loan remains unchanged, but this can help you qualify since your loan payments will be lower than a fully amortized loan.
- Balloon payment: With a balloon payment, you’ll be required to make a lump-sum payment to fully satisfy the loan balance after a specified period of time.
Loan programs that offer a variable interest rate typically have a lower starting rate than the equivalent fixed-rate option. However, while your initial starting payments may be lower on a variable-rate loan, it might be more difficult to get since some lenders qualify you based on a higher interest rate. Lenders do this to ensure that in a worst-case scenario, you can still afford the loan payments if the interest rate adjusts upward in the future.
The interest rate on variable-rate loans typically changes based on the U.S. prime rate. The prime rate is often impacted by the federal funds rate, a figure that is determined by the Federal Reserve. Our guide on the prime rate goes over what it is and why it matters in greater detail.
What Lenders Consider With Small Business Loans
In reviewing your loan application, lenders will consider a wide range of ratios to determine if you meet the eligibility criteria for the loan program. These ratios will measure aspects of your business credit and finances, and aid in the lender’s determination of your overall risk:
- Debt service coverage ratio (DSCR): This measures your company’s ability to repay its debts. It is calculated by taking your business’ net operating income and dividing it by its current year obligations. See our article on the DSCR for more information.
- Debt-to-income (DTI) ratio: This measures your monthly debt payments against your income. It is calculated by dividing your monthly payments by your gross monthly income. Our guide on what the DTI is contains examples of how this is done.
- Loan-to-value (LTV) ratio: This measures the amount of equity you have in collateral by dividing your loan amount by the appraised value of the item in question. LTV is commonly used for real estate loans and equipment financing. We’ve provided examples of how you can calculate your LTV ratio in our article on the LTV ratio.
- Loan-to-cost (LTC) ratio: This is often used for properties in need of repairs or renovations. It compares the loan amount to the total cost of completing construction on the property. See our LTC ratio article for details on how to calculate it and what it means.
- After-repair value (ARV): Often used in conjunction with the LTC ratio, ARV measures the value of a property once repairs, upgrades, and construction on a property have been completed. Check out our ARV formula guide to learn more.
- Liquidity ratios: Various liquidity ratios may be used by lenders to determine if your business has enough assets to cover its debt obligations. You can check out our guides on common ratios such as the quick ratio, the current ratio, and the fixed charge coverage ratio. Some lenders may also consider your net working capital, another measure of the solvency of your business.
- Cosigner income and debt: Getting another individual to cosign can help you qualify for a loan. This is because it gives the lender an additional personal guarantee that the loan will be repaid. Learn more about what to consider through our article on getting a business loan cosigner.
Tips on Getting a Small Business Loan
To improve your chances of not only getting approved but also landing the best rate possible, see our tips for how to get a small business loan. Following them will also help you get through the loan approval process more quickly by understanding what to expect from various lenders and loan programs.
If you are ever uncertain about the details of a loan offer you’re given, don’t be afraid to ask questions. Accepting a loan offer is not something to take lightly, as you’ll be making a commitment that could have negative consequences for your business credit and finances in the long term. Some loans may also have prepayment penalties or other fees that cannot be refunded once you’ve accepted a loan.
Common Mistakes to Avoid
To help get you through the loan approval and funding process as quickly and easily as possible, here are some common mistakes you can avoid as a borrower and business owner:
- Being unresponsive to a lender’s requests: If a lender requests documents from you, be sure to respond in a timely manner. Lenders may withdraw your application if they do not hear from you, so letting them know you have received the request and are working on it will ensure that your loan application stays active in the lender’s system.
- Submitting illegible or incomplete documents: Before you upload or send documents to a lender, ensure they are legible and contain all applicable pages. Since it can sometimes take lenders several days to review the items you’ve uploaded, providing illegible or incomplete documents can cause significant delays in processing your loan application.
- Making major changes to your business: Lenders need to see that your business is stable before issuing financing. Making major changes to your business structure, operations, or anything that impacts your business cash flow could result in your loan being denied or delayed.
- Providing more than what the lender asked for: While it may seem helpful to provide a lender with more documentation, it can often cause delays as lenders are typically required to review everything that has been sent.
Frequently Asked Questions (FAQs)
Getting a small business loan can take as little as 24 hours to as long as several months. This largely depends on the type of loan you’re getting, your business qualifications, and the lender you choose. SBA loans, for instance, often take one to three months. Small business lines of credit, on the other hand, can often be funded in just several days.
Lenders will typically consider various aspects of your credit and income. This can include things like your credit scores, debts, and other financial obligations. Your business income will also be reviewed to determine whether it is likely to continue and sufficient to repay business debt.
Getting a small business loan can be difficult due to the amount of documentation required for some loans. However, there are also many lenders that offer an easy loan approval process that requires minimal documentation for well-qualified businesses.
Being aware of common small business loan requirements can improve your approval odds, help you get a lower interest rate, and also get you funded more quickly. With that being said, the exact requirements for a loan will vary depending on the lender and loan program you choose. As a result, don’t be discouraged if you don’t qualify for financing from one lender, and be sure to shop rates with multiple companies.