There are no shortages of business loan applicants these days. Not only are there lots of needs within the business community, but with rates so low, it’s a good time to borrow. The question is, what are business lenders looking at when they evaluate an application?
How to Think Like a Lender
When you lean in and really study the loan application and due diligence process, it all comes down to one simple word: risk. A business lender does everything they possibly can to reduce the amount of risk they take on when lending out money. They’re looking for candidates who demonstrate the highest likelihood of repaying the loan in a timely fashion and without financial troubles, late payments, or complicated matters like bankruptcy or foreclosure.
In order to reduce risk – or at least their perception of risk – lenders have a set of criteria that they use when evaluating a business owner and his company. This criteria – which is typically analyzed through advanced loan origination software – may deviate slightly from one lender to another, but it’ll typically include some combination of the following:
Your creditworthiness is one of the very first things a lender will evaluate. This typically involves two separate analyses (both of which are extremely important in the grand scheme of things).
First off, a lender will review your firm’s credit rating. They’ll pull reports from agencies like Experian and Dun & Bradstreet. This will show them who you’re doing business with, what your payment record is like, and how much debt you have.
Secondly, because you’re a small business, the lender will almost certainly want to pull the personal credit reports of each owner. If you (or one of the other owners) are having difficulty making payments on personal debt – like car loans, mortgage payments, credit card debt, or student loans – the lender is going to make a note.
In their minds, you’re more likely to let a business loan lapse than a personal loan. (For example, most people prioritize a home mortgage above all else.) If you have a score below 680, you’re going to have trouble getting a business loan from most traditional lenders.
2. Cash Flow
Cash flow is the next thing a lender considers in the due diligence process. They want to see positive and consistent cash flow. More specifically, they want to know that you have enough cash flow to repay your loan (as well as any other loan payments you’re carrying).
If you run a seasonal business where cash flow comes in spurts – or have a relatively new business with sporadic ups and downs – it can be challenging to provide the cash flow numbers that a lender wants to see. However, honesty is the best policy. Prepare to have a justification if cash flow isn’t as smooth as you’d like.
3. Years in Business
Time in business is a pretty straightforward metric, but it’s also something that lenders take very seriously. Most businesses would rather lend money to a company that has been operational for five years and generates a predictable $2 million in annual revenue than a company that started 12 months ago and generated $4 million in its first year. Longevity and predictability are seen as far more valuable metrics than one hot year (which doesn’t always translate into a second hot year, etc.).
4. Plans for the Loan
You might think you can use your loan on anything you want, but the reality is that most business lenders will want details on how you intend to use it. Make sure you come to the application “table” with a documented plan for how the funds will be used, what sort of impact the funds will have, and how you plan to repay the loan in a timely manner.
5. Preparation and Precision
Finally, from a softer side of things, business loan candidates should embody characteristics like careful preparation and precision. Don’t throw out a random number just to see if it will stick. Run detailed computations and come up with a dollar amount that you need. A lender would much prefer you to show a specific number (and documentation and evidence for how you arrived at that number), than a loose figure that has no real justification.
Are You an Attractive Candidate?
The type of loan (and amount) you receive for your business is highly dependent on your risk profile. A good risk profile will result in more relaxed loan offers (higher amounts and lower rates), while a poor risk profile will result in more stringent loan offers (lower amounts and higher rates) – or even no offers at all.
If you’re uncertain of where your business stands at the moment, we recommend taking 60 to 90 days to get your financial house in order. This means gathering documents, organizing files, improving your credit score, paying off existing debts (if possible), and shoring up any loose ends. Anything you can do to lower your perceived risk level will have a positive impact on your loan application and offers!