How hard is it to get a business loan?

Small businesses generally struggle to get the funding they need, with only 48% having access to sufficient financing. Your chances of getting approved for a business loan vary depending on the overall

Although the odds of getting approved for a business loan depend on things like the overall economy, your financial qualifications and the type of loan, it’s generally quite hard to get business loans – particularly for small businesses.

Only 14.3% of big banks approve small business loans. Approval percentages of small banks and non-bank lenders (institutional lenders) currently stand at 20.1% and 24.9% respectively. Leading the way in providing small business funding are alternative lenders, who grant 26.1% of loan applications¹.

Considering 54% of small businesses in the U.S. apply for loans², it’s safe to say that a majority of entrepreneurs don’t get their funding needs met. In fact, data from Fundera shows that only 48% of small businesses actually get the kind of financing they need³.

Notwithstanding the approval rates, businesses do need loans. Whether you’re launching a startup or expanding your operations, access to credit can offer the cash you need to succeed. Besides, you may have to rely on loans when your business’s cash flow is tight. This need for external cash injection is what makes business owners ask, “is it hard to get a business loan?”

‍

Key Takeaways

• Small businesses generally struggle to get the funding they need, with only 48% having access to sufficient financing.
• A checkered credit history, short time in business, insufficient revenue, lack of collateral and absence of the required documentation all contribute to difficulty in accessing small business loans.
• While some types of business loans - like term loans - are hard to get, others like equipment financing and merchant cash advances are often easier to get approved for.
• Besides conventional loans, small business owners can also get funding from crowdfunding, grants and investors.

Factors that affect business loan approval

Your chances of getting approved for a business loan vary depending on the overall economic conditions, the type of loan you choose, and your financial as well as credit situations.

Needless to say, the prevailing economic climate is largely (if not entirely) out of the influence of small business owners. But it does play a role in loan approval. For example, the loan approval rate as of March, 2022 is 13.5%, down from a high of 27.3% the previous year⁴. This reduction is attributable to the effects of COVID-19 on small businesses and lenders.

As a business owner, there isn’t much you can do about things like global pandemics. However, certain factors that affect your odds of qualifying for a loan can be within your control. These are your financial qualifications, and include your credit history, revenue, loan amount and availability of the necessary documentation. Here’s a breakdown of all the factors that may affect your access to business loans.

1. Time in business

Many lenders look at your time in business when underwriting a loan application. They typically require that the business be established for a minimum number of years or months before it’s eligible for funding. The exact time will vary based on the type of loan you’re applying for.

Generally, the longer you’ve been in business the higher your chances of getting approved. That’s because longevity translates to lower risk. Conversely, startups and new businesses struggle to get approved for business loans because they are high risk. The company doesn’t have a long enough track record that a lender can use to judge its reliability in generating revenue for loan repayment.

That said, some alternative and online lenders have either low or no requirements when it comes to time in business. You can get approved for a loan even as a startup or with just six months of operation. But you may need to offer up a personal guarantee.

What to do if you don’t have enough time in business

There are some viable solutions that startup owners can use to access business loans. Whether they work or not depends on the terms of the lender. But here are a few that you can try:

• Apply for loans that are created specifically for startups and new businesses. These usually have no requirements for time in business. Some great startup loans include SBA microloans, SBA 7(a) loans, and business credit cards for startups.
• Get a personal loan. This won’t bring your business longevity into the picture, but the lender may look at your income, debt-to-income ratio, and personal credit score. You may also have to offer up collateral and cover origination fees.
• Consider alternative loans. They usually have extremely relaxed lending terms; some might overlook your years in business. Examples include venture capitalists, angel investors, crowdfunding, peer-to-peer lending, community development finance institutions (CDFIs). The thing to keep in mind is that most of these alternative options require a great pitch to convince lenders that you’re worthy of their investment even if your new business has no track record.

2. Revenue

Lenders typically look at business revenue and cash flow because they indicate a company’s ability to repay a loan. Generally, you’re more likely to get a loan if you have strong annual revenues coupled with a positive cash flow. Those two show that your business generates enough income to repay the new debt that it’s about to take up.

‍

‍

With that in mind, the lender may ask you to provide proof of revenue as well as cash flow statements. Some may ask for statements dating back six months while others may require full-year documentation. Whatever the case, they will use the statements to confirm that your business can service the debt. This also brings your debt-to-income ratio (DTI) into context.

Revenue requirements vary depending on the lender and type of loan. For example, you generally need $50,000 in annual sales to qualify for a short-term loan. But if you’re going for a business term loan, then many lenders are likely to require at least $90,000 to $100,000 in annual revenue.

What to do if you don’t have enough revenue

Ideally, it’s wise to wait until you have enough revenue to qualify for the loan you want. But if you’re strapped for cash, then here are some options:

• Apply for funding options that don’t have revenue requirements. These are typically secured loans like equipment financing, invoice financing, merchant cash advances, and business credit cards.
• Improve your debt-to-income ratio. At times the problem is not the revenue you generate per se, but rather the amount of income left to service the debt you’re applying for. If most of your profits go to servicing already-existing debts, you may be denied taking up new loans because your finances are already stretched. In which case, consider reducing your debt load. A good rule of thumb is to keep your DTI below 36%.

3. Credit history

When applying for a loan, there is an application process, expect the lender to pull both your personal and business credit reports to check your creditworthiness. If the reports indicate a lack of diligence in managing past debts, chances are your loan application will be rejected.

On the other hand, a solid personal credit score and strong business credit history can improve your chances of getting a loan. They indicate a history of repaying debts with diligence.

Although personal credit score requirements vary from lender to lender and depending on the type of loan you’re applying for, the magic number to keep in mind seems to be 720. Any score below that – especially if it dips below 700 – can make it hard for you to access business loans5.

In terms of business credit scores, anything between 76 and 100 on the Intelliscore or PayDex score increases the odds of getting approved for a business loan. Intelliscore is a credit rating system used by Experian while PayDex is used by Dun and Bradstreet. Those two, along with TransUnion, are the most popular credit bureaus for business credit scores.

That said, some lenders prefer the SBSS by FICO. In which case, aim for at least 160.

What to do if you have bad credit

One great way to qualify for business loans even if you have bad personal credit is to create a separate legal business entity. In other words, if your business is a sole proprietorship, consider incorporating it into a limited liability company (LLC) or S corporation.

This will allow you to build the business’s credit score independent of your personal credit history, and your company can qualify for loans using its own credit. Your task will boil down to building business credit and keeping the company’ Intelliscore and PayDex numbers above 76.

If your company is already incorporated, or perhaps you want to remain a sole proprietor, then here are additional solutions to the problem of bad credit:

• Start by building business credit and personal credit before applying for a loan.
• Consider offering the lender some collateral to act as security for the loan.

4. Collateral

Some lenders usually require collateral when you’re applying for a business loan. It provides a sense of security (to the lender) that you’ll repay the loan. And if you default on it, the lender may seize whatever you offered up to recover their funds.

It’s not uncommon for some lenders to require a personal guarantee for a business loan. In which case you may have to put up a personal asset – like house, car, retirement account etc. – to back your business loan. This is especially the case with sole proprietorships where the business owner has no liability protection.

Needless to say, if you or your business do not have sufficient collateral to back a loan, the lender may deny you the loan. Such is the case with new businesses that haven’t had enough time to amass assets.

What to do if you don’t have sufficient business collateral

One option is to offer personal assets as collateral. However, this is extremely risky and should only be considered as a last resort. If, for example, you list your house as collateral for a business loan, the lender will have legal rights to take and sell it if you default on their loan. Rather than taking such a big risk, you can consider these other alternatives:

• Apply for SBA loans. Although they require a down payment of at least 10% of the loan amount, SBA loans generally don’t have any collateral requirements.
• Try business financing that doesn’t require collateral. This typically includes alternative sources of funding, such as crowdfunding, peer-to-peer lending and some alternative lenders.
• Apply for cash from venture capitalists. The biggest downside with venture debt is that the funder may ask for equity in exchange for cash injection.
• Try grants. There are several small business grants that don’t require collateral or any form of backing. They include the National Association for the Self-Employed Grant, Nav’s Small Business Grant, and Amber Grant for Women.

5. Proper documentation

Apart from your business financial statements, the lender may ask you to provide additional documentation like tax returns, bank statements and a business plan. The latter is especially more important because your chances of getting approved for a small business loan may come down to whether or not you have a business plan, and if it’s a solid plan for the future (more on this later).

‍

‍

Beyond that, lenders use your business tax returns to verify its revenue. They also check bank statements to see where most of your business revenue comes from, and how you manage financial inflows and outflows.

‍

What to do if you don’t have the right documentation

This is pretty straightforward: collect all the documentation that a creditor is asking for. Many of them will go a step farther and specify the period to cover. For example, they may ask that you provide a balance sheet, income statement, tax returns, bank statements and budget for the past one year.

‍

6. Loan amount

When underwriting a business loan application, lenders typically use your cash flow and revenue to determine the loan amount that your company qualifies for. More specifically, many of them will evaluate your Debt Service Coverage Ratio (DSCR).

Generally, a DSCR of 1.25 or higher indicates a strong financial position⁶ and may incentivize the lender to approve the loan amount you are applying for. On the other hand, if your company’s DSCR is 1.00 or lower, it may indicate that the business is facing financial challenges. Based on this, the lender may only be willing to approve small loan amounts for your business.

While not always the case, many lenders often approve a loan amount that is between 50 and 100% of your business’s average monthly revenue⁷. If you ask for more than this, they may either give you a counteroffer or simply deny your business loan application altogether.

That said, some lenders do make out loans that are larger than 100% of the business’s average monthly revenue⁷. Oftentimes such loans are reserved for borrowers who have an extremely strong relationship with the lender and superb creditworthiness.

‍

What to do if you need a bigger amount than the lender is willing to offer

Ideally, you should only borrow a loan amount that your business qualifies for and can repay using the available revenue and without negatively affecting cash flow. However, if you need a larger amount than your revenue and DSCR allow, you can consider any of the following solutions:

• Offer collateral. By offering a business asset as security for a loan, you may qualify for a bigger loan size. The asset will make the lender more comfortable approving the larger loan amount since it (the asset) protects their financial stake in case your business defaults.
• Apply for SBA loans. SBA loans come in large amounts. You can get a general-purpose SBA loan of up to $5 million and a commercial real estate loan of up to $5.5 million. That said, it’s hard to get approved for the full amount. For example, the average SBA 7(a) loan amount in 2020 was $567,599⁸, which is still a large amount for the average small business.
• Improve other factors that lenders consider. Before applying for a large loan amount, consider improving other factors that lenders look at during the underwiring process. For example, you can wait until you have a longer business track record and strong working relationship with your lender before attempting to obtain a high-value loan. Additionally, consider boosting your personal and business credit scores, and also look for ways to increase business revenue and up your company’s DSCR.

‍

7. Business plan

Business loan lenders always require that you avail a business plan alongside your loan application⁹. A bank (or any other financial institution for that matter) can deny you a loan solely because your business plan isn’t practical. This may be the case if the business plan isn’t realistic or it clearly indicates that your company can’t generate enough revenue to repay the loan¹⁰.

To avoid such an eventuality, make sure you have a solid business plan, complete with financial projections and a well-thought-out plan for growth and success. Some lenders will want you to explain why you need the money, how you plan to spend it, and how you will repay it. You can capture all this information in a business plan. Consider breaking down your financial needs into smaller portions based on how you plan to spend the money.

For example, instead of just asking for $100,000 working capital loan, you can break the amount down into various expenses that your company needs to cover. Specify that $30,000 is for purchasing inventory in advance, $20,000 is for payroll during the low season, $17,000 will cater for equipment upgrade, $10,000 for business advertising, $14,000 will go to customer retention programs, and the remaining $9,000 will be used for business insurance. Such a breakdown indicates that you fully understand your business and its financials, and you have a reliable plan for deploying the funds.

‍

What to do if you don’t have a business plan

If you don’t already have a business plan, consider writing one before applying for a business loan. Chances are your lender will ask for one anyway. Even if they don’t, you will still want to have the plan. It will give you a clear idea of where you want to steer your company, the resources required and how to get those resources.

Pay close attention to your business plan. You want it to capture your growth plan while remaining realistic and achievable. Do not oversell because that may lead the lender to deny you a loan. Don’t hesitate to contact a professional if you need help creating a business plan.

‍

Approval rate by loan type

Small business owners have a variety of financing options available to them when it comes time to secure funding for their businesses. In addition to prevailing economic conditions and your financial qualifications, getting approved for a business loan also depends on the type of loan you’re applying for. Some loans – especially those that are secured, like equipment financing – are generally easier to qualify for. Others, like bank term loans, are typically harder to get. The business loan best for you depends on your business needs. Here’s a general lowdown on how hard it is to get various types of business loans.

1. Short-term business loan

As the name suggests, short-term business loans have short repayment terms – typically six months to one year. They are often easier to get (but not guaranteed) compared to other types of loans like bank term loans.

However, short-term business loans usually have small amounts that max out at $50,000 and higher interest rates. The upside is that lenders generally approve (or reject) these types of loans faster. You can get a yes or no response from the lender in under a day and have the funds in your account in another one or few days. This is especially the case with online lenders who have streamlined lending processes.

The swift approval makes short-term business loans ideal for covering immediate expenses like emergencies and gaps in cash flow. But they do have qualification requirements, albeit relaxed ones. Still, if you don’t meet the lender’s eligibility criteria, they may reject your business loan application.

Typical requirements for short-term loans

• At least one year in business
• Minimum of $50,000 in annual revenue
• Personal credit score of 550 or higher

2. Business term loans

Traditional bank term loans offer a fixed lump sum of cash that you have to repay over a longer period of one to 10 years. Compared to short term loans, business term loans offer bigger amounts and much lower interest rates. If your credit and finances are in order, you can get a bank loan approved for amounts that range from $100,000 all through $2 million. Interest rates can dip as low as 6% depending on market conditions.

The large amount, and the fact that it comes as a lump sum, makes term loans excellent for capital investments. You can use the proceeds to expand operations, open a new branch, launch a new product, purchase equipment etc. On the other hand, term loans are arguably the hardest type of business loan to qualify for, especially since they are mostly offered by traditional lenders like banks and credit unions.

Typical requirements for business term loans

• At least one year in business, with some lenders requiring three or more years
• Minimum of $100,000 in annual revenue
• Significant documentation and business information
• Personal credit score of 650, but many lenders will want 700 or higher

3. SBA loans

SBA loans are backed by the Small Business Administration (SBA). This federal guarantee usually incentivizes lenders to offer business owners attractive terms. SBA loans have some of the lowest rates, despite providing large amounts.

The maximum amount is capped at $5 million, making SBA loans great for capital investments as well as day-to-day business operations. But keep in mind that the SBA loan process takes 60 to 90 days. It’s not a fast way of getting business funds.

One of the best features of SBA loans is that they have long maturity periods. While many lenders generally offer a maximum of 10 years, you can get an SBA loan that comes with a 25-year repayment period.

But just like term loans, SBA loans are hard to qualify for. Although the SBA sets some eligibility requirements, it also grants qualified lenders the authority to set their own requirements without SBA review.

Typical requirements for SBA loans

• At least two years in business
• The business should have less than 500 employees and no more than 7.5 million in annual revenue
• Minimum of $100,000 in annual revenue
• Personal credit score of 640, but many lenders will want 720 or higher

4. Equipment financing

Equipment financing is a type of loan issued specifically for purchasing, upgrading and repairing business equipment and machinery. It’s an excellent way to acquire critical equipment without digging into company savings and profits. For this reason, equipment loans and financing allow business owners to free up cash for other activities.

‍

Equipment financing is an example of a secured loan, which means that the equipment bought serves as collateral for the loan. This tends to lower risk for the lender since they can take the equipment if you default, making it easier for borrowers to get approved for the loan.

Because it’s a fairly safe type of loan for the lender, it’s possible to get your hands on equipment financing that comes with good lending terms. Depending on the amount, you can easily qualify for a long maturity period coupled with a low interest rate. But you may need to demonstrate that your business generates enough revenue to meet loan repayments. A good credit score will also help.

‍

Typical requirements for equipment financing

• One to two years in business
• Minimum of $50,000 in annual revenue
• Personal credit score of 650, but you can qualify with a lower score if your business revenues are higher than $50,000
• Depending on the equipment, lenders usually require a down payment of 5% to 20%

5. Invoice financing

Do you frequently find yourself with unpaid invoices? You can borrow money against those invoices, and get instant cash. This is known as invoice financing or invoice factoring.

Lenders don’t typically grant 100% of the value of unpaid invoices. You’ll get anywhere between 80% and 90%, depending on the total value of invoices as well as your debtors’ history of settling their debts. Regardless of the percentage that you receive, most lenders generally provide immediate financing. This makes invoice financing ideal for emergencies and urgent cash flow injections.

One of the biggest advantages of invoice factoring is that it’s secured; the invoices serve as collateral. As such, most lenders don’t often consider your personal credit before approving you for this type of loan. This makes it one of the easiest business loans to qualify for.

Typical requirements for invoice financing

• At least six months in business
• Minimum of $50,000 in annual revenue

6. Merchant cash advances

A merchant cash advance (MCA) is technically an advance, not a loan. Nonetheless, your small business receives the cash advance in exchange for a percentage of future debit and/or credit card sales. The lender basically gives you a lump sum of money, and deducts a pre-agreed percentage from every sale that you make on your card terminal.

For example, they can deduct 5%, 10% or 30% - it all depends on how you agree with them. Whatever the case, merchant cash advances have very short repayment periods. You’ll typically need to make payments on a daily or weekly basis.

On the other hand, merchant cash advances are fairly easy to qualify for, especially if your business has strong sales. Additionally, funding often happens in hours, which makes this type of loan great for immediate cash needs.  However, you usually end up paying a lot more for this type of loan than the others mentioned previously so this is best left for emergencies.

‍

Typical requirements for merchant cash advances

• At least six months in business
• Minimum of $40,000 in annual revenue
• Personal credit score of 400 or higher

Alternatives to conventional small business loans

As you may have noticed, the biggest hindrances to accessing small business loans are bad credit, short time in business, and insufficient revenue. If any of these (or other factors) are making it hard for you to get the funding you need, you can consider looking at non-bank and non-institutional sources of business finance. Below are some alternatives to traditional and conventional business loans:

Bootstrapping

Bootstrapping is when a business owner relies on their personal savings to start and grow a business. As you make sales, you take that money and reinvest it in growth. With diligence and good finance habits, bootstrapping can ensure that the business supports itself without needing any external capital injection.

While it may require some sweat and tears, bootstrapping may be a viable solution if your loan applications are constantly denied or if you simply don’t want to take on any debt. But you’ll need to save as much as possible and also plan for continued funding of the business.

Grants

A small business grant is basically free financial help that your company gets to keep running. You don’t have to pay it back or exchange it for equity. Grants don’t even have interest. The trick to getting a small business grant is finding one that you can qualify for. Some that are worth a shot include:

• Federal grants – these are offered by the federal government. Grants.gov is a good place to start your search for federal grants. Beyond that, you can also check if your business qualifies for USDA Rural Business Development Grants, or Small Business Innovation Research and Small Business Technology Transfer programs.
• State grants – these are mostly regional grants. You can check whether your state has SBA sponsored grants by visiting the Small Business Development Center. Additional grants include the Economic Development Administration as well as minority grants.
• Corporate grants – federal, state and local governments are not the only organizations offering grants. The private sector has some notable small business grants of its own, too. They include the National Association for the Self-Employed grant, FedEx Small Business grant, Fast Break for Small Business, Visa Everywhere Initiative, and Patagonia Corporate Grants Program.

Crowdfunding

If you have a good business idea, you can join a crowdfunding platform and request people to fund your business. You basically raise money from a large number of people, who pool together small, individual amounts until you meet (or surpass) your targeted cash goal. Some of the best crowdfunding sites include:

• Kickstarter – it’s one of the most popular crowdfunding platforms with lots of users. That makes it relatively easy to pool funds if you have a solid business plan.
• Indiegogo – funders on this site love clever ideas that can solve everyday problems. If your business is involved in finding unconventional solutions to regular issues, you may strike it big on this platform.
• GoFundMe – this site is mostly used for personal appeals of cash. It’s a great place if you have a charming story about you or your business that can convince users to back you.
• Fundable – created specifically for small businesses, Fundable makes a lot of sense for any entrepreneur who is struggling to access financing.
• SeedInvest – this platform specifically serves startups, which makes it the ideal place to be if your company doesn’t have years in business.

Loans from family and friends

It’s not uncommon for entrepreneurs to get some (or all) of their initial and operational capital from friends and family. This can be a good deal, especially if they won’t charge you a high interest. In fact, some loved ones are usually willing to offer money that you won’t have to pay back. That said, you may still need to present them with a business plan that can show where their money is going.

Investors

If push comes to shove, you can look at bringing in angel investors and venture capitalists. Only consider this option as a last resort because they will want a piece of your business in exchange for funding. This will be even more complicated if you’re a sole proprietor because you might be forced to restructure the business to fit in a partner.

Where can you find investors? LinkedIn is a good place to start. Run a quick search of angel investors and venture capitalists, and pick one or a few who you feel might offer a good deal. Other social media platforms like Twitter and Facebook are also packed with investors.

‍

References

1. 21 Mar 2022, Forbes
2. 21 Mar 2022, Shopify
3. 21 Mar 2022, Fundera
4. 21 Mar 2022, Truic
5. 21 Mar 2022, Business News Daily
6. 17, Aug 2022, Investopedia
7. 17, Aug 2022, Nav
8. 17, Aug 2022, AdvisorSmith Solutions
9. 17, Aug 2022, Guidant
10. 17, Aug 2022, U.S. Chamber of Commerce

‍