There are several factors that are typically considered when a credit team is reviewing a business profile to issue a deny or approve decision to finance equipment or provide working capital. There is some flexibility among lenders in considering different factors, but there is a common ground from which many work. Lenders with tighter, more stringent guidelines are typically the ones offering the lowest rates, so they have a narrower risk profile for each decision. More flexible lenders, meaning those who can work with higher-risk customers, have higher rates; they win some, they lose some (customer default) but they get to keep their ROI profit margin.
The following are the basic factors to look out for so you know where you fall and if there are too many red flags then you may decide not to apply for funding and go in a different direction. Learning and preparing ahead of time will help you understand the process so that at the end of the day you don’t give up and say, “Why didn’t I get approved?” These are just general guidelines and exceptions can be made, but they will always need to minimize the risk to the lender in some way.
Factor 1: Time in business. This is the easiest to verify since the secretary of state where you live will have the business file on file; he must check and make sure he is in good standing and active. Less than two years puts you in the ‘startup’ business category, which means rates will be higher and the amount you can finance will be capped at $30K, $50K, or $100K depending on the other factors. Two to five years in business is the midrange and still requires the owner’s personal guarantee and more than five years in business is the ‘established’ category and can be approved without an owner guarantee with loan amounts limited only by the business performance.
Factor 2: Personal credit. For businesses that have to personally guarantee, the owner’s credit rating is very important; particularly the younger the business. Low, damaged, or poor scores indicate how the owner could operate his or her business and is a strong indicator of success or failure and possible default. If your credit is troubled, a credit repair service should be the first step before applying for any financing. Most credit repairs take at least three to six months.
Factor 3: Cash flow. Bank balances in your business account, personal account, and savings must be adequate to pay off the new debt along with sufficient protection for emergencies. If you deposit $1000 and spend $1000, then there are no reserves for emergencies or new debt, even if the new equipment will make you a lot of money. Underwriters are looking for cash inflows and reserves that can cover business slowdowns, emergencies, etc. The amount needed will depend on the amount you want to finance.
Factor 4: comparable lending experience. Credit seeks to see what you have financed in the past; For newer businesses, your personal loan will come into play. Car loans, home loans, credit cards, and the like will be important to see how they have managed. As a business ages, you’ll want to make sure you finance even small pieces of equipment and take out business credit cards to help establish business credit history. Some vendors offer financing for small tools, and even if you can pay cash, you should finance it to help build your profile. In the long run, comparable credit becomes very important and, for many lenders, a necessity.
Factor 5: Business credit. Dun & Bradstreet and Paydex are common offices underwriters use to check trade history. These reports reveal lawsuits, ties, pending lawsuits, and a history of late payments. You should request a copy and work to rectify any issues and if an agreement is being worked on then a letter of validation should be filed. Credit will always consider a good story to support any problem, as long as you have solid documentation. Open links need to be worked on and resolved as very few lenders will approve any business with open links.
There are many other factors that a credit analyst will consider, but these five are the backbone of most credit decisions. You don’t have to be optimal on all five to get approved, but at least two of the five must be strong. Otherwise, some lenders will allow a family member to sign as a guarantor for the loan, which is typically a last resort for business owners. A cosigner might allow you to get approved, but you’ll still fall into a higher risk, higher rate category. In general, he should assess where he qualifies, fix what he can, and if he decides to move forward with the funding request, at least he’ll be better prepared for the outcome.