Getting a Business Loan
A business loan can help you grow your small business—it can get you the funds to invest in equipment, more retail space, new employee talent, additional goods for sale, and much more. Before you rush into your local lender to fill out a loan application, you need to make sure the loan makes good business sense for your company and for the lender. Afterall, lenders want to ensure they’ll be repaid!
Your personal finances
Believe it or not, your personal finances can be important for taking out a business loan, especially if it’s your first business loan. To asses risk, lenders may look at your credit score. A low score could indicate you’re a high-risk borrower and your application may be denied, or your loan options may be limited or pricier: higher interest rates, bigger down payment requirements, and/or the need for collateral.
To get the best loan offers and rates, aim for a personal credit score in the high 600s at minimum. Some alternative lenders will give borrowers loans with a score as low as 500, but the interest rate will still be higher and the total loan amount offered will most likely be lower.
If your credit score isn’t ideal for the terms you want on a business loan, consider holding off on the application until you can bring your score up.
Guaranteeing the loan
Lenders need to hold someone responsible for paying back the loan, regardless of the success of the business. For this reason, loans to new or young businesses often require the owner to make a personal guarantee on the loan, meaning you’ll pay back the loan amount plus applicable interest and fees no matter how your business does. If you can’t repay the loan, your personal credit will suffer.
One way to guarantee a loan is to pledge collateral for it, which means if you can’t repay the loan, the lender may take possession of the pledged asset to offset their lost money. This can improve your odds of being approved. You can pledge assets such vehicles, equipment, or personal property like your home.
Calculate how much you can borrow
A key number to calculate before you apply for a business loan is your debt service coverage ratio, or DSCR. This number shows you, and the lender, the relationship between your business’s income and debt. Here’s the basic formula:
Debt Service Coverage Ratio = Net Operating Income ÷ Debt Obligations
Your net operating income includes all revenue minus operating expenses. Your debt obligations include all debt, interest, and fees for the next year.
To be in a strong borrowing position, your DSCR should be at least 1.25. This number means you have enough income to cover your current debts plus an additional business loan.
The next step is calculating an amount you can afford to borrow. Divide your net operating income by 1.25. Then subtract your current debt obligations from this number. The final number is the amount of additional debt you can safely take on.
What you’ll need to apply
In addition to a healthy personal credit score, possible collateral, a calculated DSCR, and loan amount, lenders will want to see:
- A business plan
- Pro-forma statements
- Your most recent income tax returns (usually two years’ worth)
- Six to 12 months’ worth of business bank statements
- Profit and loss statements
- Balance sheets
Where to borrow
Just like with a mortgage or vehicle loan, it’s a smart idea to investigate a variety of lenders to understand who will give you the best options. If your business already has a credit card or other financial resource with a lender, that’s a good place to start. You can also speak with your personal credit union. In general, credit unions are more willing to lend to local small businesses and offer lower interest rates.
Larger banks are also an option, but they tend to have a more impersonal, hands-off approach that could lead to a loan application rejection. Online lenders and microlenders are another option. They sometimes offer faster approval, but the loan amounts are usually smaller.