Five Common Credit Factors for Qualifying for a Small Business Loan

There are five basic factors that all lenders look at before they will agree to loan you money for your business:

1. Credit history. One of the primary factors lenders look at is the condition of your personal and business credit. This is reflected in your credit score. Before you even start shopping for a loan, request a copy of your credit report from all three major reporting agencies: Equifax, Experian, and TransUnion. Review it carefully for mistakes, and resolve any discrepancies before you start the application process. Learn more about Cleaning Up Your Credit Record.

Your personal credit score is associated with your Social Security number, but business credit reports are tied to your tax ID number. If you have not established business credit, the first step is obtaining a tax ID number from the IRS. To apply, complete Form SS-4 (PDF) and submit it to the IRS.

2. Vested interest. Business loan applicants should have a reasonable amount of equity invested in their businesses. Lenders want to know that you will work hard to make your business a success. When they see that you have invested a substantial amount of your own money in your venture, they will assume that you will work hard to make it a success.

Also, strong equity with a reasonable amount of debt can help a business weather tough economic times. Little or no equity leaves a business vulnerable, increasing the risk of default.

3. Working capital. Working capital is your current assets less your current liabilities. Working capital can also be thought of as cash on hand, or what is available to pay current debts and keep your business running. A lack of adequate working capital increases the risk that your business will fail, and makes lenders much less likely to issue you a loan.

4. Ability to repay. Banks want to see two sources of repayment: cash flow from your business and a secondary source — typically collateral. Lenders will look at your past financial statements, including those of any business partners. They will want to see your:

  • Personal assets and liabilities
  • Personal tax returns for the past three years
  • Balance sheets for the past three years
  • Profits and loss statements for the last three years
  • Accounts receivables and payable aging

If your business has consistently made a profit, you are more likely to get approved. But if your business has not been consistently profitable, you can increase your chances of getting a loan by including detailed information of new opportunities, new contracts, or other information showing that your company is not a “risky business.” Review Should You Personally Guarantee a Loan to Your Small Business? for some answers to this question.

Many lenders also require evidence of collateral. Collateral is required for all SBA loans, although the SBA does not necessarily decline a loan where inadequate collateral is the only unfavorable factor. Collateral can be business assets and personal assets outside the business. If you plan to purchase equipment and other assets with borrowed funds, you can assume that this will be used as collateral for the loan.

5. Experience and character. With a few exceptions — franchises are a notable one — you should have experience in the type of business you plan to run. If you don’t, lenders will expect you to hire or partner with people who have appropriate experience. At the very least, you should be able to point to business acumen and managerial experience.