Your company's time in business, your personal credit, your business credit, the amount your business is requesting, the type of business, and your collateral all play a major role in obtaining working capital.
Time in Business
In most cases, lenders want you to be in business for two years or more before they will even begin to consider you for a business loan. Some want 3 to 5 years or more in business and 2 Years of profitable tax returns which reflects net income of $50,000 or more. The main reason is that a substantial number of businesses fail within the first 5 years. Another is that if you haven't been in business for 2 years or more, you won't have the tax returns or financial statements they need to look at to gauge your cash flow. In addition, it takes most companies two years or longer before they begin to show profits that will qualify them for loans.
The credit reviewed in Business Loan requests is not limited to Business Credit. Your personal credit is reviewed and considered a majority of the time. Minimum credit score requirements will vary over time and based on the type of loan being requested. Currently, most business financing requests require 640 and higher.
Many people believe when they apply for small business loans that because the request is in the name of the business, their personal credit won't be or shouldn't be looked at. No so. In most cases, personal credit will be reviewed and the owners(s) of the company will be asked to individually guarantee the loan. The reason is that most companies are small companies and if the owner or president has a personal credit problem, there is a good chance it may or will affect the business, including checking accounts, business loans, etc. The larger a company is, the less likely a personal credit problem an owner is having will affect the company. The size of a company is usually determined by the Annual Sales and the number of employees.
If a company is a Sole Proprietorship or Partnership, the personal credit of the owners will always be reviewed, and the owners will always be required to sign as a guarantor. This is because the owners are not a separate legal entity from the company. They are the company. A corporation is legally a separate entity from the owners. The owners own stock in the corporation, but it can be a small percentage of the stock.
Generally, the only time the personal credit of an owner may not be reviewed and the owner not asked to be a signer on the loan is for corporations that have been incorporated for 3 years or longer with strong business credit. Otherwise, your personal credit will be reviewed as part of the decision.
When a business applies for a loan, the lender often will check to see if the business has a business credit file. The company most often used for this purpose is Dun & Bradstreet, although there are others such as CIT and Experian. The primary things lenders look for in this report is to verify the starting date of the company, the high credit, and look for what is known as a "Paydex" score. This score is an overall risk score and is used similarly to the "bureau" score on the personal credit file.
Approveable Paydex scores begin at around 60, depending on other factors, such as amount of the request, type of request, personal credit, but most lenders like to see a Paydex Score of 70 or higher, preferably 75 or higher. The lender will also consider the high credit reflected on the report and see if there are any current past dues showing in the trade section. Often, the reportings are outdated, so you should check to make sure your listings are current and accurate before you apply. You should first determine if you even have a business credit file.
If you do not have a business credit file, it is an advantage, sometimes critical for a business to have a strong business credit file. If you do not have a business credit file, you can establish one, but will have to pay a few hundred dollars for it. Long term, this is money well spent. The Credit agency will ask you to give them your company's trade reference and creditor's basic contact and account information. They will call to verify the information and report it on your file. Normally, this will take up to a month. A faster approach is for you to call your trade references and have them call the Business Credit Bureau(s) to report about the accounts you have with them. This will speed things up greatly. The Business Credit agencies will give you a good idea about what kind of creditors they will list as business credit tradelines. It is sometimes different than personal credit trade lines.
Acme General Contracting buys concrete periodically from Concrete Central. The most they have ever bought or owed at one time was $30,000. This would be, along with timeliness of payments, the high credit Concrete Central would report to Dun & Bradstreet about Acme General Contracting. Dun & Bradstreet will often even report accounts like Federal Express type in your file. They will mix them in by industry rather than itemizing them and the reviewer of the report will not know specifically who the trade reference is. Contact Dun & Bradstreet and other business credit agencies for details.
If your business is asking for a relatively small amount, under $50K, then you may be able to apply and receive a decision by completing an application and avoiding providing financial statements, tax returns, personal financial statements. Considering that many companies try very hard to show the lowest net income figure on their company returns, this will be a liability when applying for credit and a reason to avoid submitting financial statements.
If you are a large company with say $10MM in sales per year and you are seeking a $500,000 loan request, then be prepared to provide at least 2 or more years tax returns, accountant audited financial statements and 6 months bank statements for the credit review process. The more you ask for, the more that will be requested, and the more it will be scrutinized.
Type of Business
Some lenders favor certain industries over others. Restaurants, Food Service, Bars, Vending Companies and other retail oriented business are not favored by institutions. They will take your application and will give you the same impression that you are just as likely to get a business loan with them as any other industry, but the reality is different. Many traditional lenders in general prefer Medical or Legal Professionals, large manufacturing companies or non-retail service companies.
The type of collateral you have to offer when applying for small business loans is an important factor in determining if you will be approved. You must qualify from a credit and cash flow standpoint before your collateral is considered. When you are at that point, the collateral can be a make or break issue.
Liquid Collateral such as Certificates of Deposit, Corporate Savings Accounts, Money Market Accounts are most preferred by traditional banks. When banks suggest or ask for this type of collateral, many frustrated applicants state that if they had the amount of their request in cash, they wouldn't need a business loan. This is true, but many businesses recognize that it can be dangerous for them to use most or all of their existing cash because if something comes up for which their business needs cash fast, their company can run into a problem. This is why some companies apply for loans even if they have the cash on hand. Very large companies commonly do this and use their cash on hand as needed for other things.
Some Banks are so conservative, they may decline your request even if you have a Certificate of Deposit in cash for the amount of your request. Their reasoning is that they want a high comfort level that you will pay the loan back from your cash flow. They do not want to have to cash in your collateral to repay the loan, so they don't want to make small business loans to companies they feel will have trouble making the payments solely because the company has a certificate of deposit to cover the loan.
Real Estate, especially personal Real Estate such as a home with a lot of equity is one of the most favored types of collateral. Other than a Certificate of Deposit or Savings Account being held as collateral, lenders feel that they will most easily be able to recover their money in the event of a default with a home. A lender can sell a home more quickly and recover a greater percentage of the loan than with a commercial piece of property or other types of assets. In the current market climate wherein home prices have declined for several years, banks have scrutinized real estate far more. In the long term though, Real Estate will always be high on the desirable collateral list.
Lenders will take commercial pieces of property as collateral, but want to see more equity in commercial property than in personal property such as homes. Lenders know that it will take them longer to sell commercial property and they will have to offer a much greater discount from the appraised value if they want to sell it fast, which they need to do to recover their money in the event of a default.
Accounts Receivable will be valued as collateral depending on the quality of the companies that owe the money, the time the receivables have aged, and how many companies account for the total Accounts Receivable. The pay history of these accounts will also be looked at. How aggressively your company works to collect the accounts receivable on a timely basis is considered.
Equipment is not considered a primary or significant type of collateral by lenders. Equipment loses it value fairly rapidly and in the event of a default, if the lender decides to collect the collateral, the lender will have to arrange for it to be picked up. It will often be sold by a third party vendor in the secondary market. The lender will recover a small fraction of the outstanding loan and take a significant loss. For this reason, most lenders will over collateralize loans with equipment as by a significant margin, often 200% or more of the wholesale value, though this differs with different lenders.
Blanket Liens are liens that cover all business assets you own. Lenders will often try to take everything your business owns, including personal assets such as your home as collateral for small business loans. As a business owner you intend to grow your business and you may need additional small business loans for things such as marketing expenses, expansion, raw materials, relocation, etc. within the next 5 years. If the lender has all of your business assets and personal assets as collateral, you will be in a very difficult position the next time your business needs a loan. Knowing the key points above which Lenders look at is critical in achieving success obtaining a business loan.
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