Nowadays, there is no shortage of applicants for business loans. Not only are there a lot of need within the business community, but with rates so low, it’s a good time to borrow. The question is, what do commercial lenders look at when they assess an application?
How to think like a lender
When you lean in and really study the loan application and due diligence process, it all comes down to one simple word: risk. A commercial lender does everything they can to reduce the risk they take when lending money. They look for applicants who demonstrate the greatest likelihood of paying off the loan on time and without financial problems, late payments, or complicated issues like bankruptcy or foreclosure.
In order to reduce risk – or at least their perception of risk – lenders have a set of criteria that they use when evaluating a business owner and their business. These criteria, which are usually analyzed through advanced loan origination software, may differ slightly from lender to lender, but they will usually include a combination of the following:
Your creditworthiness is one of the very first things a lender will assess. This usually involves two separate analyzes (both of which are extremely important in the grand scheme of things).
First, a lender will look at the credit rating of your business. They will pull reports from agencies like Experian and Dun & Bradstreet. This will show them who you are dealing with, what your payment record looks like and how much you owe.
Second, because you are a small business, the lender will almost certainly want to pull each owner’s personal credit reports. If you (or any of the other homeowners) are having trouble paying off your personal debts, like car loans, mortgage payments, credit card debt, or student loans, the lender will make a note of it.
In their mind, you are more likely to let a business loan expire than a personal loan. (For example, most people prioritize a mortgage first.) If you have a score below 680, you will have a hard time getting a business loan from most traditional lenders.
2. Cash flow
Cash flow is the next thing a lender considers in the due diligence process. They want to see positive, consistent cash flow. Specifically, they want to know that you have enough cash on hand to pay off your loan (as well as any other loan repayments you make).
If you run a seasonal business where cash flow is spotty – or if you have a relatively new business with sporadic ups and downs – it can be difficult to provide the cash flow numbers that a lender wants. see. However, honesty is the best policy. Prepare to have a rationale if the cash flow is not as smooth as you would like.
3. Years in business
Time spent in business is a fairly straightforward measure, but it’s also something lenders take very seriously. Most businesses would rather lend money to a business that has been in operation for five years and generates a predictable annual revenue of $ 2 million than a business that started 12 months ago and has generated 4 million dollars the first year. Longevity and predictability are seen as much more valuable metrics than a hot year (which doesn’t always translate into a hot second year, etc.).
4. Plans for the loan
You might think you can use your loan for whatever you want, but the reality is that most commercial lenders will want details on how you plan to use it. Make sure you show up at the demand “table” with a documented plan of how the funds will be used, what kind of impact the funds will have, and how you plan to repay the loan in a timely manner.
5. Preparation and precision
Finally, on the softer side of things, business loan applicants should embody characteristics such as careful preparation and precision. Don’t throw away a number at random just to see if it will hold. Perform detailed calculations and find the amount you need. A lender would much prefer that you show a specific number (along with documents and evidence of how you arrived at that number) than a rough number that has no real justification.
Are you an attractive candidate?
The type of loan (and the amount) you receive for your business depends heavily on your risk profile. A good risk profile will result in more flexible loan offers (higher amounts and lower rates), while a bad risk profile will result in more stringent loan offers (lower amounts and higher rates) – or even no offer at all.
If you are unsure of where your business is today, we recommend that you take 60-90 days to get your finances in order. This means gathering documents, organizing files, improving your credit score, paying off existing debts (if possible), and fixing issues. Anything you can do to reduce your level of perceived risk will have a positive impact on your loan application and your offers!