What You Need for a Small Business Loan
By Rohit Arora Published June 05, 2014 Small Business
People often ask me how to get a loan to start a business, or what type of documentation is needed to apply for a small business loan. Although every bank has its own requirements, many documents are mandatory across lenders. Before applying, here are the basic small business loan requirements to keep in mind.
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Loan Application Form: Many of the biggest banks – and some of the smaller ones – have invested in technology that will allow online small business loan applications. However, far too many banks still require would-be borrowers to come into their branches and fill out paper applications in order to get funding. Applying for loans at multiple institutions can be harmful because each one will do a hard pull of your business credit history. The more hard pulls, the less chances you have of getting money because the banks interpret it as a sign of desperation that you are shopping around. Thus, they will question your creditworthiness.
Personal Information: Banks expect borrowers to provide basic personal background information. This data includes current and previous addresses, aliases, criminal record (if any), educational level, and other information.
Business Plan: Anyone looking to secure a small business bank loan should have a business plan. The document provides a detailed explanation of what the business is and where the owner hopes to take it. The business plan should include:
- Executive Summary: A one-page explanation of the business, its goals, operations, marketing efforts, and revenue model is very important. In fact, it may be the only portion of the business plan that a loan officer will bother to read, so be sure that it is succinct.
- Business Description: What does the company do? How will it make a profit?
- Local Market and Competitive Landscape: Describe where the business will be based and who the target audience will be. Assess the competition as objectively as possible and then describe how you plan to differentiate your business.
- Product or Service: Explain how your product or service works. Highlight what makes your business one that will attract customers.
- Sales, Marketing and Promotion: Outline how you will inform the marketplace about your company and build awareness. Describe the marketing tools you will use, including a web site, advertising, public relations (traditional and social media), trade shows, sampling, sales promotions, etc.
- Management Team: Describe who will run the business and their experience level(s).
- Financial Data: Provide a break-even analysis, cash flow projection, sample balance sheet and profit-and-loss statements.
- Investment Information: Lenders want to know how much money the owners are putting into the company. If you are unwilling to invest much of your own money into it, investors will be wary about doing so. Provide an estimate of sales, revenues, and what type of return investors can expect.
- Appendices: Any research you have conducted, charts, graphs, logos, and other images.
Personal Credit Report: Your lender will obtain your personal credit report as part of the application process. However, you should obtain a credit report from all three major consumer credit rating agencies before submitting a loan application to the lender. Inaccuracies and blemishes on your credit report can hurt your chances of getting a small business loan approved. It’s critical you try to clear up any discrepancies before beginning the loan application process.
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Business Credit Report: If you are already in business, be prepared to submit a credit report for your company. It is important to review your business’ credit report before beginning the application process. A score of 650 or higher generally is considered a good score. If your business credit score is 600 or lower, you may have a difficult time securing financing from a traditional lender, such as a bank or credit union.
There are tried and true ways to increase your business credit score if you have a poor history or perhaps no credit history at all. Clearing up past-due debts and opening business credit cards and paying the monthly balances in full and on time are steps in the right direction.
Income Tax Returns: Most banks require applicants to submit personal income tax and business income tax returns for the previous three years. Providing business tax returns for a startup is difficult, of course. For new businesses, the personal return carries a lot of weight.
Financial Statements: Banks typically look for profit and loss (P L) documents, cash flow statements, and a balance sheet. Many lenders require one year of personal and business bank statements to be submitted as part of a loan package.
Collateral: Some financial institutions do not require collateral, but many of them do. Loans involving a high degree of risk will require substantial collateral. Lenders want to know the cost/value of personal or business property that will be used to secure a loan.
Legal Documents: Banks may require borrowers to submit the following items:
*Articles of Incorporation, which may be filed by an attorney or a service provider
*Business licenses and registrations required for you to conduct business
*Copies of contracts you might have with any third parties
Banks, both large and small, and credit unions often have similar lending criteria. Many big banks turn away requests for startup loans because of their requirements of providing three years worth of financial data. In such cases, smaller, regional banks and credit unions may be more favorable. They understand the local environment better and are vested in helping local businesses grow.
Since the crash of Lehman Brothers and the ensuing “credit crunch,” the approval of SBA-backed loans (with 75% guarantees) have become increasingly popular. Each year, the SBA seems to report new records in funding amounts. However, as with any transaction involving government entities, there is much paperwork to be filed and the process can become very time consuming.
For borrowers who need money quickly or who have poor credit scores – or perhaps no credit history at all – alternative lenders is an option to consider. Cash advance companies, microlenders and CDFIs are often willing to lend when traditional institutions will not. However, the money comes with a premium price; some lenders charge 30-40% interest on the loans. Before you know these details before signing on the dotted line.
Peer-to-peer (P2P) lending has grown tremendously in the past few years, but it is a form of financing more common for startups, non-profits, and artistic ventures. P2P lending is a challenge for businesses that are not sexy – like construction companies, for example. Further, there are certain types of professionals, including doctors and dentists, who may not want to be seen having to raise money in such a manner.