Getting Approved for a Small Business Loan

One of the leading causes of business failure is insufficient

start-up capital. But the sad reality is banks rarely loan money to those that most need help. Instead, loans are more likely to go to businesses that have been in operation for two years or more and are profitable.

An estimated 95 percent of entrepreneurs open businesses with capital from their own pockets and from relatives, friends, and others in the community. As a result, business owners need to be prepared and persistent if they want to land a business loan. For a thorough overview of this topic, make sure to read our Step-by-Step Guide to Getting a Business Loan.

The most important criterion banks use in determining whether to loan money is the company's ability to repay. Like other corporations, banks must answer to investors and stockholders. And unpaid loans make them look bad.

When a bank processes a business loan application, it will typically ask some version of the following questions:

• How much money does the business want?
• Is the business profitable enough, and does it have enough cash flow, to service the debt?
• Does the business have collateral to cover the loan?
• Is there a reasonable balance between debt and equity?

Banks also want and expect business owners to risk their own funds in the venture. They won't likely take a risk when the business owner hasn't.

The types of businesses most likely to receive loans are those with a history of success in paying their bills, demonstrating their ability to meet financial obligations.

Regardless of status — as a startup or an established business — the first step in trying to obtain financing is for the business owner to develop a rapport with the people who can provide the most help. For instance, by inviting the target bank manager to open a file on a company, the business owner can then send quarterly or yearly profit and loss statements, and when his or her business becomes eligible for financing, the bank will already know the company.

A bank will also check, and double-check, a business's credit history. Looking at old debts and repayment histories is one of the only ways to determine creditworthiness. Small business owners with a shaky credit history (either personal or professional) have little chance of landing a loan.

It's a good idea for business owners to check their credit histories before trying to get a loan. Correcting erroneous data or resolving any inconsistencies before applying for a loan will increase a business's chances of getting one. For more information on your credit information, read our comprehensive Step-by-Step Guide to Understanding Business Credit.

Small businesses also need a solid business plan to inspire potential lenders' confidence. Generally, the plan covers business operations, marketing efforts, competition, management ability, and financial projections for three years, plus a cash flow projection and balance sheet demonstrating the worth of the business. The plan also precisely identifies goals and serves as a resume for the owners and management team.