The Basics of How to Get a Small Business Loan
Essentially, lenders want to know three things, experts say: Why do you need a business loan? Can you afford it? And most important, can you repay it?1 To convince lenders on the ability to pay off loans, businesses may need to provide several types of supporting information, according to a U.S. Small Business Administration (SBA) blog post.2 That can include proof of sufficient assets, collateral, and reserves that would enable the business to continue making loan payments despite market fluctuations. Existing small businesses may need to demonstrate cash flow that's adequate to repay a business loan. New businesses may need to show a track record of success in a similar venture.3
One way to think about this is to put yourself in the lender's shoes, according to the SBA. It's much like a job interview, where you might try to develop an understanding of what the employer is looking for and prepare the application to anticipate questions accordingly.4
Loan Purpose
For larger loan amounts, lenders typically need detail on what the business expects to use the money for, so they can ensure it makes sense to lend. For example, does the business need money to fund construction or leasing of a new facility, to buy equipment, or to weather a seasonal downturn?5
A good business plan can help clearly demonstrate this need to a potential lender, although not every loan application requires a business plan.6 However, some experts note that a solid business plan is also key to helping a small firm understand how much it needs to borrow and how fast it will be able to repay the loan.7 Because lenders have a limited amount of time to examine each application, a good executive summary is an important part of the business plan; in fact, one expert says it may be the only part of the plan that a loan officer has time to read.8 The executive summary typically encapsulates business goals, operations, marketing efforts, and revenue model.9
Demonstrating the Capacity to Repay a Business Loan
Lenders may look for a variety of documentation to provide sufficient evidence that a small business can repay a loan. These documents can persuade lenders that a business has adequate cash flow and assets to make loan payments. For small businesses, lenders often ask for the owner's personal as well as business financial information.10 These documents can include:11
- Business and personal bank statements, which provide evidence of cash flow as well as financial reserves;
- Business and personal tax returns;
- Business financial statements, including profit and loss information and assets;
- Business legal documents, including articles of incorporation and other agreements;
- Information about any existing loans;12
- Business and personal credit history.
Depending on the size of a small business loan, lenders may more carefully review these statements and accounting records, so it's important to make sure they are complete, correct, and thorough, experts say. It may help to have a certified public accountant look them over and anticipate any potential issues that may arise as lenders analyze metrics such as cash flow, gross margin, debt-to-equity ratio, accounts payable, and accounts receivable.13
Lenders often use business and personal credit history, including the credit score, to help evaluate loan applicants; information from other lenders is considered a strong indicator of whether a business is a good candidate for a new loan. So experts say it's a good idea for businesses to know their own credit standing and take steps to clean up credit if necessary.14,15
New businesses may need to demonstrate a track record of profitability and success in a similar business endeavor.16 For new as well as existing small businesses, lenders may view a company more favorably if it has strategic investors, professional venture capital investors, or well-known angel investors, some experts say.17
Assets as Collateral for Small Business Loans
Lenders may require business or personal collateral, particularly for larger loans, to provide a secondary source of repayment in the event of a loan default. Depending on the situation, a lender may consider only certain asset classes — such as real estate, equipment, accounts receivable, and inventory — while other assets such as goodwill may not be taken into account, according to experts.18 Some assets, such as equipment and real estate, may require appraisal.19
Character and Other Conditions
Lenders may also consider less-tangible factors such as the character of the management team and the company's online presence. For example, a lender may ask for professional references and do a background check to evaluate character and trustworthiness.20 Some experts say it's a good idea to examine the business's website, social media presence, and online reviews to check that the company creates a good impression, since some lenders will examine those online resources as part of due diligence.21
