When you need capital, you need preparation as well. You might be generating good revenue with good credit, but without the preparation, you might not be able to secure financing. Before you make a loan application, lenders want to determine that your business is worth the risk. So, before you start, prepare yourself and understand your borrowing requirements, have a business plan in place and all the necessary loan paperwork. Here are a few things you should do before you apply, and increase your chances of approval for small business loans:
- Determine Your Borrowing Amount
Before applying for small business loans, carefully scrutinize your expenses and determine how much loan payments you can afford. You can determine your affordability by calculating your Debt Service Coverage Ratio. It is a measurement of your current business cash flow to pay current debt obligations. The Debt Service Coverage Ratio (DSCR) is calculated by dividing the net operating income (NOI) by the annual debt.
Lenders are likely to lend small businesses that have cash flow equal to their monthly loan payment (1.0 DSCR). If the ration is a bit higher, you can be an ideal candidate for the lenders.
Determining your borrowing amount is crucial. You might be thinking of borrowing a large sum in order to build capital reserve cushion, but might end up paying more borrowing costs and interest payments and crushing your bottom line eventually.
Do your due diligence, carry out a loan performance analysis to lower the risk, and ensure a positive return on your investment before you apply for a small business loan. This performance analysis will help you determine how a small business loan will financially affect your small business.
- Analyze Your Credit Score
The next most important factor in small business loan eligibility is a credit score. You should know both business and personal credit scores before applying. Lenders consider personal credit score as a crucial part of their small business loan application process, especially for startup financing. The better your credit score is, the better your loan terms and rates will be on your small business loan. Your personal credit score is tied to your Social Security Number (SSN), and your business credit is tied to your Employer Identification Number (EIN).
Start scrutinizing your credit report by getting it free from the top credit bureaus (Dun and Bradstreet, Experian, and Equifax) to identify mistakes and resolve them. If there are any discrepancies in your credit report, it can lower your chances of loan approval as well as negatively affect your credit score. Public records like bankruptcies, judgments, tax liens, arrest records, divorces appear on credit reports along with other variables, such as the size of your business and time in business. Therefore, it’s essential to have them clear before you start the loan application process.
FICO scoring system has different ranges for both types of credit scores. For personal credit score, the range is 300 to 850, and for a business credit score, the range is 0 to 300, depending on your business model. Besides your personal credit scores, the factors that can affect your business credit score include your loan repayments, credit utilization, and credit accounts.
- Create a Solid Business Plan
Creating an organized, well-thought-out and comprehensive business plan is the basis of your small business and demonstrate to potential lenders about your business profitability.
Having a solid business plan in place will help you in determining your credibility among potential lenders. A great business plan can help you secure funding for your small business, or expand your operation. It typically includes the following:
- Executive summary
- Company description and objectives
- Business primary products and services
- Management skills and backgrounds
- Market strategies and analysis
- Your target customers base and the competitive analysis
- Sales and marketing plans
- Business development plan
- Operations & management plan
- Financial projections
- An appendix that supports documents for your business plan
Read this article to learn about creating a great business plan for your small business.
- Guidance from Business Mentors
As an inspiring entrepreneur, you likely need support and guidance about starting and managing your business. Frequently, these anxieties become so crushing that you might not know where to turn to for help. Getting guidance from business mentors can also help you systematize your business plan, and connect with relevant resources. You can find business mentors via specialized associations, former employers or from your networks. Here are some of the best places to start your search for business mentors:
- Networking Events
- Entrepreneur Hot Spots
- Social Networks like LinkedIn and Twitter
- Small Business Development Centers (SBDC)
- SCORE Association
- Industry Centers
- Indirect Competitors
- The Network of Friends and Family
- Explore Local Business Resources
Exploring local business resources is another great option for small businesses. You can get counseling, guidance or financial support for your small business. Here are some of the best local business resources to get started with:
- The Small Business Administration
- SCORE (Service Corps of Retired Executives)
- US. Chamber of Commerce
- National Federation of Independent Businesses
- The State Small Business Credit Initiative (SBCCI)
- National Main Street Center
- Veteran’s Business Outreach Centers
- Women’s Business Centers
Documents Required for Small Business Loans
Lenders typically require significant documentation as part of their small business loan application process. The required loan paperwork includes the following:
- Personal Information. Your personal information includes details about your assets and liabilities, address, names used, criminal record and educational history.
- Business Plan. Not every loan types require a business plan, but a solid plan can demonstrate your business capability, team strength, and overall credibility. Your business plan should include financial projections and detailed financial statements.
- Credit Score: Get a copy of your credit reports from the reporting agencies.
- Tax Returns. A copy of your business and personal tax returns for the previous three years.
- Bank Statements. At least one year of personal and business bank statements.
- Collateral. Some loan programs don’t require collateral, while some require to lower the risk involved in small business loans.
- Loan Usage. You also need to a provide document on how you will use the loan amount and for what purpose.
- Debt Schedule. A document containing all your business’s outstanding loan, interest and monthly payments with dates.
- Legal Documents. Based on your loan’s particular requirements, you may have to provide documents of business licenses and registrations, business lease, franchise agreements, business formation, and third parties’ contractual copies.