How to get a Business Loan with Bad Credit
Access to working capital helps small business owners manage working capital and expand their business. It can spell success, or doom, for a struggling business owner, depending on how easy it is for them to obtain it.
Traditional lenders have strict requirements to qualify for a business loan, and often will not lend to those with credit scores below 750. They also prefer to work with businesses who have been successfully operating for many years, show growth, and already have strong cash flow. It’s an old joke but true, often to get approved for a bank loan you need to prove that you do not need it.
The reality is that many successful small business owners may not have great credit, even if their business is doing well. When a bank loan is not an option, a merchant cash advance and other types of alternative lending become a valid business funding source. For many, alternative business loans are a better option.
Alternative lenders specialize in working with those who have been denied for funding at banks. They exist to help small business owners succeed. Here is how to qualify for a business loan with bad credit.
Why do Lenders Avoid Lending to Business Owners with Bad Credit?
Many lenders view your credit score as a reflection of risk. To them, a lower credit score indicates that you lack financial management skills and could make late payments or default on a loan. Lenders worry that you will engage in the same behavior if they extend you credit.
This is largely because of the components that go into calculating a credit score. If you make payments late, default on a loan, or frequently overdraw a checking account, points are deducted from your overall score. Alternative lenders will lend to borrowers with scores as low as 500, but traditional lenders avoid the risk.
As well, whether or not they appear on your credit report, there are a few automatic disqualifiers for a business loan. These include:
- child support
- certain bankruptcies
- tax liens without a payment plan
- no Social Security card
A low credit score can also be caused by simply not having enough data. If you have paid cash for most of your life, or are younger and have yet to build credit, the credit agencies do not have enough data to build a score. In an odd way, you are punished for not using credit and being able to meet your expenses with cash.
The first thing to consider before applying for your business loan is to see if there is any way you can improve your credit score.
How quickly can you Fix Bad Credit?
There are actions you can take to improve your bad credit score, but it is not a fast process. It can take up to seven years for a late payment to fall off your report, and a bankruptcy can take up to ten years. In the meantime, you can take steps to improve your score that do not depend on erasing the past.
Set up auto-payments for all your bills so that you never make a late payment again. Work to reduce your debt to income ratio and your debt utilization ratio, which will push your credit score higher. For more information, read our business owner’s guide to repairing your credit.
Alternative lenders understand that because it takes so long for past mistakes to fall off a credit report your credit score may not reflect your current financial management skills. It is for this reason they offer business loans with poor credit. Their credit score requirements are much lower than those at traditional lenders, and for some products they will lend to those with scores as low as 500. Instead, they consider other factors when deciding whether or not to underwrite a loan.
How to Meet Alternative Lender Requirements
If you want to get a business loan with bad credit, you will have to meet the requirements of an alternative lender. To improve your odds of being accepted, take the following steps.
One of the major factors for alternative lenders in making lending decisions are your monthly revenues. Your monthly cash flow is a measure of your repayment ability. For bad credit business loans the lender will want to see minimum monthly revenues of $8,000, for short term business loans $10,000.
If you know intend to apply with an alternative lender, work to increase your monthly revenues. Run specials and sales contests and boost your marketing efforts on free social media channels. Ask existing customers to write positive reviews on online sites such as Yelp to help attract new customers or solicit referrals.
You can also try to generate more revenues from existing customers. Examine their businesses and see if you can add on more services or products to deepen your relationship. The success rate on selling to new customers can be just 5-20%, whereas it jumps to 60-70% if you are selling to an existing customer.
To qualify for a business loan with bad credit, make sure that you meet a lender’s revenue minimums before applying.
Alternative lenders will likely ask to see several months of bank statements as part of your application process. They want to confirm that your business is cash flowing regularly and thus can support repayment. Try to maintain consistent daily and monthly balances.
Before applying for a bad credit business loan, make sure that you go several months without overdrawing or incurring non-sufficient funds (NSF’s) on your account. Try to leave as much cash as possible in your checking account or link it to a savings account to avoid overdrafts.
Consider incentivizing some customers to pay on time, rather than over several months, to show all their revenue in one month. Offer terms such as Net 10, which is a 10% discount for paying in full within ten days. The lender wants to see strong revenue growth each month prior to approving a loan.
Improve your Financials
Look at your debt to income ratios and other financial measurements to identify opportunities for improvement. A debt service coverage ratio is the amount of your current net income that must be put towards debt payments. Lenders consider this ratio when determining whether you could take on more debt. Simply paying down existing debt will improve it.
If your DSCR ratio is decent, consider your debt utilization ratio. This is the amount of your available capital you are currently using. Say you have a credit limit of $20,000 on a credit card and have a balance of $15,000. Your debt utilization ratio is 75%. Paying down the balance, or even transferring it to another card, could improve your ratio.
Another way to up your odds of getting a bad credit business loan is by pledging collateral. Lenders accept various forms of collateral to secure a loan, from investment accounts to physical assets. If you default on the loan, you are giving them permission to seize the collateral to recoup their losses.
Because collateral lowers their risk, lenders will often extend lower interest rates to a borrower with collateral or they will consider lending to a borrower who is riskier in other ways.
Evaluate your business’ existing assets and consider pledging them for a loan but be careful! If your business could not function without that delivery truck or the commercial oven, you might not want to risk losing it.
Determine if you can Afford the Loan
The lender will perform due diligence on your loan application, but before you even apply, you should know if you can afford the loan. It is tempting to borrow if your business is in trouble, or experiencing a cash crunch, but borrowing without a clear repayment plan only leads to more trouble. Defaulting on a loan has serious consequences.
Put together a spreadsheet which lays out potential loan payments. If you add them into your business’ budget, can you still cover your operating expenses? If you are unable to formulate a clear repayment plan, one which does not impair your business’ ability to keep operating, you should not apply.
Also, calculate what your debt service coverage ratio would be after taking out the new loan. How will the new debt impact your ratios? A ratio that goes too high should give you pause. Seriously consider if your business can support the additional loan payments.
Another factor to determining if you can afford a loan are current and future cash flows and profitability ratios. Generally speaking, if a loan’s funds will return more value to your business than the loan’s interest rate, you are safe to borrow. If you pay 12% on a bad credit business loan but the return on that investment is 20%, you have made money. Before signing the agreement, you should have a good idea of the ROI you expect to see from the loan’s capital.
In short, can you make loan payments from your current and future cash flows, and will they help your business?
Be Ready for Underwriting
Underwriters examine all of a loan applicant’s documents to verify their credit-worthiness and honesty. When you complete a loan application the lender will ask for information about assets, existing debt, and cash flow. If you are prepared for this step of the loan approval process, it will go smoothly and quickly.
Gather all credit card statements, bank statements, tax returns, business licenses, and any other documents you think the lender might require before submitting your application. If possible, have them scanned and ready to email.
Try to anticipate any lender questions. If there are any negative items on the reports, such as an overdrawn checking account one month, think of an explanation that you could offer. A temporary issue, such as a customer who paid late, is better than one that reoccurs.
If you are ready for the underwriter before you even apply for the loan, you will get to the funding stage much faster.
Apply for the Loan!
Shield Funding has an easy, online application that you can complete. It gathers preliminary information that help us assign your loan to a specialist. Based upon the data you provide we will call to let you know if you qualify and for how much capital.
If you decide to proceed, you will have to complete a loan process application with more information. This is the point where the underwriter may request documents. Depending on the amount you are borrowing, a loan decision can be returned in just 24 hours.
All that is left to do then is select a payback plan. Shield Funding allows for daily, weekly, bi-weekly, and monthly repayments through an automatic deduction from your checking account.
Alternative lenders have their own set of underwriting requirements which verify a business owner’s credit-worthiness separate from a credit score. Working with them, a small business owner with poor credit can qualify for the business funding they need. Following these steps will help guarantee your business loan approval.