12 Small Business Loan Requirements That You Need To Know
This article is part of a larger series on Business Financing.
If you’re trying to qualify for a small business loan, there are several requirements that you need to know about. We’ve compiled a list of key small business loan requirements that’ll help you save time and potential stress as you go through the loan application process.
To ensure that you’re fully prepared to meet the small business loan requirements to obtain financing, you can download our comprehensive checklist.
1. Loan Amount
The amount of financing you need can directly impact your loan options. Different lenders have different thresholds for minimum and maximum loan amounts. Traditional lenders, such as banks and credit unions, are generally able to provide larger loan amounts. However, they also typically have stricter qualification requirements. Online lenders will often have more lenient qualification requirements, but many online lenders have lower maximum loan amounts and potentially higher interest rates.
2. Intended Use of Funds
Many lenders will want to know your intended use of the funds when you apply for financing. While some lenders provide general working capital loans, other loan types like equipment financing have very specific loan purposes. To qualify for a loan with a specific purpose, your intended use must match that requirement.
Most lenders have requirements for annual revenue as well as how long your business has been in operation. Before applying for a loan through a particular lender, you should make sure that your business’s annual revenues and time in operation either meet or exceed these minimum requirements.
Also, many lenders maintain a list of industries that they’re unwilling to lend to. In many cases, the restricted businesses are those that typically have a perceived ill reputation, such as adult entertainment and, more recently, the legalized marijuana industry. Each lender maintains a list of businesses it’s unable to lend to. While many openly publish their lists, other lenders may not be as transparent, and you may have to ask directly before applying.
Some entrepreneurs are surprised by how much impact their personal and business credit has on the ability for them to obtain business financing. Lenders will look at a potential borrower’s character and history, debt to income (DTI) ratio, and personal credit score as part of their loan decision process.
Personal FICO Credit Score Categories
800 to 850
740 to 799
670 to 739
580 to 669
300 to 579
Many Small Business Administration (SBA)-preferred lenders will only accept personal credit scores of at least 680 when a business applies for an SBA loan. Other types of financing, such as invoice factoring or accounts receivable (A/R) financing, will have less strict credit score requirements. While many small business lenders advertise that they have lower minimum credit score requirements, this doesn’t mean that a borrower with a low credit score will qualify for a good interest rate.
While there are a few different measurements for business credit, the most commonly used scoring system is the Dun & Bradstreet PAYDEX score. The PAYDEX score is an indicator of how likely your business is to repay its debts on time. It’s based on your business’s payment history during the prior 12 months and is measured on a scale of zero to 100. Lenders are going to want to see that you have a good business credit score.
Dun & Bradstreet PAYDEX Categories
Dun & Bradstreet PAYDEX Score
80 to 100
50 to 79
0 to 49
New businesses often have credit scores in the fair to poor range as they haven’t had the opportunity to build up their business credit history. Having a low business credit score doesn’t preclude you automatically from obtaining financing. However, you will likely be required to provide a personal guarantee and qualify for financing based on your personal finances.
Unless you intend to apply for an unsecured business loan, you likely will need to have some collateral to pledge against your loan. Collateral serves as a type of insurance to the lender. If you default on the loan, the lender can take possession of the pledged collateral as repayment.
Your collateral will need to have sufficient equity, which can be measured through an appraisal, for a lender to utilize it for financing. A discounted value can be assessed to collateral depending on the type, which will establish the borrowing base that the lender will use. Collateral can be equipment, real estate, or personal property. In cases where a loan doesn’t require collateral, a blanket uniform commercial code (UCC) lien will likely be assigned on the assets of the business.
In addition to assigning physical collateral, many lenders will also require that business owners sign a personal guarantee. A personal guarantee holds you personally responsible for the debt in the event of the business being unable to pay its obligation to the lender.
6. Incorporation Documents
Your lender will want to see all legal documents pertaining to the establishment of your business entity. These documents state what type of entity your business is set up as, detail who else has an ownership interest in your business, and provide proof that your business is operating legally. Required legal documents pertaining to your business entity may include:
- Articles of incorporation
- Corporate bylaws
- Limited liability company (LLC) operating agreement
- Partnership agreement
- Franchise agreement
7. Employer Identification Number
An employer identification number (EIN) is assigned to a business much like an individual’s Social Security number. This number is used to identify the business for tax purposes, opening bank accounts, applying for credit, and other business activities. While not all businesses are required to have an EIN, if you have employees or are operating under certain business structures, you’ll be required to apply for an EIN.
8. Licenses & Permits
A business license is required to operate a business in most states and many municipalities. The exact requirements for when you must apply will vary. Your lender will want to see proof of proper permitting and licensure as part of your loan application. This will assure the lender that you’re compliant with state and local licensing laws and prove that you’re the owner of the business.
9. Leases & Contracts
If your business has entered into any legal contracts with other entities, you’ll likely be required to provide copies of these contracts to the lender. These may include contracts with suppliers or purchase agreements for real estate, business acquisition, or equipment purchase.
Some examples of other contracts and agreements that you may have to provide include:
- Any contracts you have with suppliers or other third parties
- The sales agreement, business financials, and information about the business you’re purchasing (for acquisition loans)
- Commercial real estate purchase and sales agreement (for real estate acquisition)
- Equipment purchase agreement (for equipment financing)
- Lease agreements for the location that houses your business or any equipment used in conjunction with your business
Exact requirements may vary: Being aware of these common small business loan requirements in advance will help you qualify for the financing your business needs. Exact qualification requirements for a business loan vary by lender, making it important that you inquire about the requirements before completing an application.
Part of meeting the qualification requirements for your business loan will likely include having adequate insurance coverages. This includes having proper coverage for general liability insurance, property insurance, or auto insurance. The exact requirements for insurance coverage will vary based on the type of loan you’re applying for and the collateral you’re using to back the loan. Additionally, if you apply for an SBA loan, you may be asked to carry a life insurance policy in case something were to happen to you.
11. Business Plan
Even if you’re not required to submit a business plan with your loan application, this is a business tool that you should already have prepared prior to seeking financing. Your business plan serves as a guide for your business and shows that you have put thought and research into the many facets of your business. If you’re applying for an SBA loan, your lender will require a business plan with your application. An SBA business plan will also need to list all owners in the business and their ownership stake.
While competitor and market research should be part of your business plan, your lender may request that you provide them with a more in-depth market study. The market study will show that you have a firm understanding of the industry, your competition, and consumer demand for your product or service.
Having a financial forecast will help the lender see the viability of your business and your loan request. Your projections should be realistic and include notes that state the basis of how you developed your forecast. If you apply for SBA financing, your business plan will need to provide three years of annual projections and at least one year of cash flow projections that are broken down by month.
12. Financial Statements
There are several financial statements you should be aware of and be prepared to provide to a lender when you apply for business financing.
One of the financial documents you’ll likely be required to provide is your most recent balance sheet. Your balance lists your assets, liabilities, and owner’s equity as of a specified date. The lender will review your balance sheet to understand the net worth of your business. A balance sheet is effectively a snapshot of your business’s financial position at one specific point in time.
Recent business bank statements are often required as part of the loan documentation requested by lenders. In general, you can expect to provide up to 12 months’ worth of business bank statements. While other financial documents provide the lender with an overall idea of your business’s financial standing, bank statements provide insight into the business’ day-to-day management of cash flows.
Profit & Loss
Another business financial document the lender is likely to request is a profit and loss (P&L) statement. The P&L statement may also be referred to as an income statement, statement of earnings, or a statement of operations. The P&L statement will allow lenders to calculate the earnings before taxes, depreciation, and amortization (EBITDA), which is a measure of a company’s profitability. This document provides a summary of your revenues and expenses over a given period of time like month, quarter, or year. Your lender will review it to see if your business is currently making money or not.
Your lender will want to see copies of your individual and corporate tax returns. This is especially true if your business income and expenses are reported as a schedule C of your personal returns. In general, you’ll be expected to provide the prior three years of tax returns to the lender. The lender will review your tax returns to verify the profitability of the business as well as the revenues and expenses.
Business Debt Schedule
Another financial document that many lenders will want to review is your business debt schedule. A business debt schedule lists all of your debts, including the remaining unpaid balance, the amount of the payment, and the payment due date.
A/R & A/P Aging Reports
An A/R aging report groups all unpaid customer invoices by the number of days outstanding, including those receivables that are past due. Similarly, an accounts payable (A/P) aging report shows all unpaid expenses, including current liabilities, by the number of days outstanding. These two reports show the lender how proficient your business is in collecting payments from customers and how promptly it pays its outstanding bills.
Personal Financial Statement
Many lenders, especially if you’re applying for an SBA loan, will require you to include a personal financial statement with your financial documents. The statement will include the assets and liabilities for every owner with at least 20% ownership in a business.
What Lenders Consider With Small Business Loans
There are many ratios, formulas, and other considerations that lenders will look at when determining whether your loan application should receive approval. The exact number of items looked at will vary based on the complexity of the loan, the type of loan considered, the asset that may be collateralized, and other considerations. We’ve outlined a few of them below:
- Debt service coverage ratio (DSCR): This is a financial measure used to determine the ability of your business to repay debt, calculated by dividing your net operating income by your total debt and interest payments. A DSCR of 1.25 or greater is desired by banks to approve you for a loan.
- Liquidity ratios: Depending on the lender, the quick ratio, current ratio, or the fixed charge coverage ratio may be looked at to determine the ability of your business to cover current liabilities. Some lenders may look at net working capital or current assets formula as well to gauge the health of your business.
- Business efficiency: Besides profitability, your ability to utilize assets to generate revenue can be looked at by potential investors and angel funders who are looking for scalable businesses to lend to.
- Potential improvements with property: If you’re applying for a commercial mortgage to purchase an existing property with the goal of expanding or renovating the piece of real estate, a lender may attempt to determine the loan-to-cost (LTC) ratio or after repair value (ARV) of the improved property.
- Conflicts of interest: To avoid any potential conflicts of interest, your lender may request that you provide a disclosure that lists any ownership interests that you or your partners have in other businesses. In addition to ownership interests, you should also be prepared to disclose any other professional affiliations you have, such as being on the board of directors for another business.
How to Qualify for a Small Business Loan
There are several aspects to consider that can increase your chances of qualifying for a small business loan:
1. Determine the Amount & Purpose of the Loan
The first step in qualifying for a small business loan is to determine what you’ll be using the loan proceeds for and how much financing you need. Selecting a lender that allows your intended use of funds and can provide the amount of funding you need will improve your chances of being approved.
2. Improve Your Personal & Business Credit Scores
Improving your personal credit score and business credit score won’t only increase the likelihood of qualifying for a small business loan but will increase the number of lenders that will be willing to lend to you and likely result in better rates and terms from those lenders. To improve either your personal or business credit score, the most important step you can take is to pay your bills on time.
A personal credit score of 680 or greater allows you to qualify for better rates and terms with most lenders. Lenders use your credit score to determine your level of risk as a borrower; a higher score equates to less risk to the lender, which means a lower interest rate for you. If your score is low, you may need to utilize a cosigner to help improve your odds of approval.
While banks use the prime rate as a starting point with interest rates, your credit score, the use of any collateral, and business performance ultimately determine what your interest rate will be.
3. Know the Lender’s Minimum Requirements
Knowing a lender’s minimum requirements in advance can allow you to pre-determine if it’s worthwhile for you to apply. It won’t make sense to apply for financing with that lender if you can’t meet their minimum requirements, as your application will immediately be denied.
4. Have a Strong Business Plan
Having a well-developed business plan isn’t only important to obtaining financing, but it’s also crucial to the success of your business. Preparing a business plan forces you to consider many different aspects of your business and how those various pieces work together to form a successful business. Lenders will want to see that you have spent significant effort on your plan, that you have evaluated your competition, and have detailed and achievable financial projections.
5. Gather All Necessary Documentation
Review your loan application to determine the documents you’ll be required to submit with your application. If there are documents on the list that you don’t have readily available, take time to gather or create the necessary paperwork to provide with your application. If you’re unsure of what’s required, reach out to the lender for further clarification.
6. Provide Proof of Collateral
If you’re using business or personal assets as collateral for your loan, you’ll need to provide proof that these assets aren’t being used as collateral on another loan, as well as the current value of the assets. An appraisal may be required as part of the lender’s approval process and must be completed by a certified appraiser. If you’re using the loan to purchase equipment, the equipment itself may be used as collateral for the loan. In some circumstances, lenders may be willing to use collateral that secures more than one loan or have more than one piece of collateral secure one loan.
7. Complete the Application
When completing the application, make sure that you do so legibly if it’s a paper copy and that all fields are completed in full. If you have a question about any of the details requested in the application, you should contact the lender for clarification. Most applications will include a list of supplemental documentation that needs to be submitted as part of a complete application package. Use this list as a checklist and provide all of the documents requested.
Mistakes to Avoid When Applying for a Small Business Loan
Applying for business financing can be complicated and often requires a lot of effort on the part of the small business owner. To ensure that your application isn’t returned or rejected needlessly, make sure you avoid some of the common mistakes that small business owners make when applying for funding. These mistakes include:
Not Knowing Terms of the Loan
Before applying for a loan, you should be aware of the loan terms and conditions. Some of the things you should find out from your lender include:
- Whether the interest rate is fixed or variable
- Prepayment penalties, if any, and how they’re structured into the loan
- Approximate closing costs and if those can be financed into the loan
- Any other conditions that may apply
Failing to Complete Applications
Failing to entirely complete the application can result in the lender having to make follow-up inquiries with you to get any missing information or the application being returned to you without action, resulting in delays to the approval process. Be sure to take some time to thoroughly review the application, ensuring that all of the information requested has been provided.
Including Inaccurate Information
The information you provide on your loan application should be completely accurate. Keep in mind that a lender will thoroughly review your application and use supporting documents to verify what you report. Providing false information on a loan application (or worse, falsifying documents) is considered fraud and can result in legal action including fines and possibly jail time.
Forgetting to Submit a Required Document
Small business loan applications generally include a list of business documents you’ll need to provide the lender to substantiate the information you provided. Prior to submitting your loan application package, you should review this list to make sure you have provided everything that was requested. Forgetting to submit a required document could delay the processing of your application or cause it to be returned or rejected as an incomplete application.
Making Major Changes to Your Business
Lenders will want to see that your business is stable and making significant changes to key personnel or business operations may cast doubt on that stability. If you have recently made major changes to your business, you may want to wait six months or more before applying for significant financing—like an SBA loan. Depending on the nature of the change, such as a change in management, a lender may still be willing to work with you. Before applying, contact the lender to determine whether these changes will impact your ability to qualify for a loan.
Missing Lender Deadlines
Throughout the loan process, your lender is likely to request that you provide additional documentation or clarification of information you have already provided. The lender will often provide a deadline by which this additional information must be received for the application to proceed. Missing a deadline could cause your application to be terminated, so it’s crucial that you stay on top of these deadlines.
Knowing the requirements for a business loan allows for you to be prepared to provide all necessary information to a lender when you apply for financing. While lenders each have their own specific qualification requirements and metrics, much of the information that you’ll be required to provide will be standard regardless of which lender you choose to work with.