By Carl Faulds
If you operate a small- or medium-sized business and are seeking a business loan, a bad credit history can prove a huge hurdle. Indeed, in 2013 the Coleman Report indicated that 63 percent of small business owners had approached their banks for a loan, but only 27 percent had been accepted.
So what can you do to ensure that you’re a winner, instead of falling by the wayside?
1. Know your credit score and the risk it represents.
Traditionally, businesses need a credit score of 650 or more to secure a bank loan. This is because the majority of banks use computerised models to assess creditworthiness, with personal relationships and business plans being of far less importance. What’s more, they’ve become much more risk averse since the financial crash of 2008, meaning that their loan criteria are now more stringent than ever.
The first step to success is knowing your credit score, which can be obtained from any of the major agencies. A business credit score report will include information on your banking, insurance, and leasing arrangements, and details of any bankruptcies or court judgments. If you have a record of paying debts late–or defaulting altogether–your score is likely to be relatively poor.
2. Know your personal credit score too.
If your business credit score represents a bad risk for lenders, they may consider advancing a loan with a personal guarantee. This can be a good way of circumventing bad business credit, but it means if your company is not able to repay the loan, you will be personally liable for it.
Once again, your credit score will mean the difference between acceptance and rejection, so you should obtain your credit report from one of the major agencies. As with your business score, this will be significantly affected by the amount of credit you have outstanding, your record of reliability in making timely payments, and any court judgments against you.
3. If your credit score is bad, set about repairing it.
As already stated, a bad credit score can be shaped by your previous financial behaviour. However, it can also result from misreporting, which is why it is important to study your credit report before applying for a loan.
If there are errors in your credit report, you should immediately inform the credit bureau; it has a legal obligation to keep your details up to date and accurate. Even if the poor score is a result of your bad decisions, you can repair it by paying off outstanding debt, reducing loan and credit card balances, and generally tidying up your finances.
4. Have a good business plan.
In some cases, banks will take a flexible approach when a business has a marginal or poor credit score. In this situation, their decision will be based on the credibility of the business plan and of the principals.
A good business plan should set out a clear vision of the future and a realistic road map to achieve your goals. Similarly, you should prepare persuasive CVs for yourself and any partners or key employees.
5. Be prepared to pay a high rate of interest.
Where a bank shows leniency and lends to a small business with a poor credit score, the interest rate will be significantly higher than normal. Chances are repayment terms will be less flexible too, and the approval process is likely to be lengthy. Even with these restrictions, you will probably be asked to advance a high level of collateral to secure your loan.
6. Offer security.
It is much easier to obtain secured loans rather than unsecured financing, for obvious reasons. With a secured loan, should you fail to make repayments, the bank can seize the asset used as collateral. Of course, many startup businesses have few, if any assets, so you need to consider carefully whether you wish to secure a loan on, for instance, your home. While this significantly increases the chances of acceptance, and may reduce interest rates substantially, if something goes wrong with the business you could find yourself homeless.
7. Talk to alternative lenders.
Unlike banks, alternative lenders are not fixated on credit scores when they assess potential business borrowers. They can offer a number of useful services, from emergency loans (meaning you can have money in your account inside 24 hours) to asset-based financing, where you borrow against the value of your premises, plant, or equipment.
Many businesses also find invoice factoring and discounting extremely useful tools. These services enable you to borrow up to approximately 85 percent of the value of your invoices as soon as you issue them, with repayment being made when your clients pay. With invoice discounting, you retain control of your own debtor ledger, whilst with factoring the finance company assumes responsibility for chasing up debts and aims to secure rapid payment to minimise the amount of interest you have to pay. The effect on your cash flow can be quite remarkable, giving you the working capital you need to get ahead.