There are several factors that are typically considered when a credit team is reviewing a business profile to issue a denial or approval 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 the strictest and most 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 that can work with higher-risk clients, 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 keep in mind so you know where you fall and if there are too many red flags then you may decide not to apply for financing 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 have to somehow minimize risk to the lender.
Factor 1: Time in business. This is the easiest to verify as 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 the 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 mid range and still requires personal guarantee from the owner and more than five years in business is the ‘established’ category and can be approved without a guarantee from the owner with limited loan amounts only by the business performance.
Factor 2: Personal credit. For businesses that have to personally guarantee, the credit rating of the owner is very important; particularly the younger the business. Low, damaged or low scores indicate how the owner could operate their business and is a strong indicator of success or failure and potential non-compliance. If your credit is in trouble, 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 enough protection for emergencies. If you deposit $1,000 and spend $1,000, then there is no reserve 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 downturns, emergencies, etc. The amount needed will depend on the amount you wish to finance.
Factor 4: comparable loan experience. Credit seeks to see what it has 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 been managed. As a business ages, you’ll want to be sure to 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 bureaus that underwriters use to review trading history. These reports reveal lawsuits, bonds, 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 validation letter should be on file. Credit will always consider a good history to back up any issues, as long as you have solid documentation. Open links need to be worked out 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 top of all five to get approval, but at least two of the five must be strong. Otherwise, some lenders will allow a family member to co-sign the loan, which is typically a last resort for business owners. A co-signer might get you approved, but you’ll still fall into a higher-risk, higher-rate category. Overall, he should assess where he qualifies, fix what he can, and if he decides to move forward with the funding request, he’ll at least be better prepared for the outcome.
