Tips for Acquiring Bad Credit Business Loans
Running a small business can be incredibly rewarding; it can also be one of the biggest challenges a person can experience in their lifetime. This is especially true for those who suffer from poor credit. A low credit score can make many parts of life difficult, including obtaining a small business loan.
Many lenders are hesitant to work with those who have bad credit; however, this doesn’t necessarily mean that obtaining a loan is entirely out of the question.
Types of Bad Credit Small Business Loans
There are a number of different types of small business loans for bad credit, all of which come along with their own unique set of pros and cons. While some options might not be good for those with low credit scores, others may serve as an ideal fit. Bad credit small business loans work like most other types of loans, however there may be specific terms and requirements in terms of how they can be utilized.
Here are some of the best types of small business loans for those who are still working on improving their credit and some helpful tips on how to obtain this type of business funding.
Business Line of Credit
In many ways, a business line of credit acts in a similar manner to credit cards. That is, most business lines of credit come along with restrictions in terms of the amount that can be borrowed, and interest is drawn only on the amount of money that is actually borrowed (not the limit). One of the main benefits of a revolving business line of credit is that it can be used to purchase anything that qualifies as a business expense—inventory, equipment, gaps in cash flow, and much more.
So long as you repay what’s borrowed on a regular basis, you can continue to use a business line of credit indefinitely in most cases. Bear in mind, however, that those who have poor credit should expect some constraints with business lines of credit, such as reduced maximum spending limits and higher interest rates. Also, of all the bad credit business loans available this is the most difficult to obtain, and is reserved for the best of the worst credit profiles.
Merchant Cash Advance
Sometimes you need capital immediately and simply don’t have time to wait for it to become available. For those who find themselves in this situation, a merchant cash advance (MCA) may be the best option for small business financing. With a typical MCA, capital is advanced from a lender in exchange for a percentage of the business’s daily credit card sales. This type of loan is very popular among those who have just recently started a business and find themselves strapped for capital as there are almost no credit requirements, although it should be noted that MCAs often come along with exceedingly higher interest rates.
One of the benefits of having a high credit score is the ability to obtain long-term loans with favorable interest rates. While this type of financing may be challenging for those with low credit to secure, short-term business loans offer a similar set of benefits—namely, the ability to inject quick capital into a business, even if your credit is less than stellar. Short-term loans also allow borrowers to obtain significant dollar-value financing.
While interest rates can be higher (sometimes significantly) than other forms of loans, they represent a viable option for those with bad credit who need financing to succeed at their business ventures.
Delayed payments, lack of communication and other factors make invoicing one of the most stressful aspects of running a small business. Many people don’t realize that there are ways to mitigate these issues, however, one of which is called “invoice factoring.” With invoice factoring, any invoices that are sitting around unpaid are sold off to a lender, resulting in an influx of capital that can protect against cash-flow problems. This type of lending is often referred to as “accounts receivable financing” and may be a good fit for those who invoice clients on a regular basis.
Purchasing expensive equipment is one of the biggest challenges faced by small business owners. One way to workaround financial constraints when attempting to outfit a business with the equipment you need is simply known as equipment financing. Unlike more traditional loans, equipment financing can only be used to purchase specific items such as computers, machinery, vehicles and other types of equipment. It might not be ideal for a business that’s trying to address cash-flow issues, but for others, equipment financing may provide solutions to challenges that can otherwise seem insurmountable.
Defining “Bad Credit”
When people talk about having “bad credit,” they’re generally referring to their FICO score, also commonly referred to simply as “credit score.” While errors and discrepancies can exist, a person’s FICO score usually serves as a comprehensive representation of how they have handled paying debts in the past, which lenders often use as information to determine someone’s creditworthiness. Though not a hard and fast rule, those who have missed a fair amount of payments over time for things like credit cards and loans will likely have lower credit scores than those who have not.
FICO scores can range from as low as 300 to as high as 850, with most Americans hovering around 700. In order to qualify for most “bad credit” loans, a person must have a FICO score of approximately 500 or higher. Lenders look at scores as benchmarks for determining how much risk a potential borrower may present. Other factors may also play into a decision, such as the business’s cash flow, assets and potential for success.
Tips for Getting a Small Business Loan with Bad Credit
One thing to keep in mind is that acquiring a small business loan is not usually something that happens overnight. There’s a fair amount of upfront work and preparation that needs to be done, even for those who have great credit. By taking the time to ensure that your application is buttoned-up tight, you can reduce your chances of getting a denial letter while also potentially working toward more favorable terms and interest rates.
Not sure where to start? Here’s a primer on how you can improve your chances of obtaining small business funding if you have bad credit.
Tip #1 Develop a Rock-Solid Business Plan
One of the first places to start before you even think about the role credit plays in your ability to obtain financing is by developing a well-defined business plan. Whether you need it for the lender you choose or not, it can still help develop a well thought out plan for your company moving forward, and it will have you ready to answer any lender questions quickly and efficiently. The plan can help provide the lender with a better understanding of what you’re trying to achieve, as well as the peace of mind of knowing that you have given your venture a great deal of thought—it’s also an effective way to take the focus off of your poor credit score, which is only a small snapshot of your potential as a business owner.
There is a wealth of information available in books and online about how to craft a sound business plan, and many people choose to write their own. That said, enlisting the help of a professional who can assist you in fleshing-out your ideas and coming up with accurate numbers can be highly beneficial. It may cost a bit more than taking on the challenge yourself, but the end result can mean the difference between being able to obtain a small business loan and having to finance the business on your own.
Tip #2 Work on Improving Your Personal Credit
Many people with bad credit assume that little hope exists for actually repairing it, but this couldn’t be further from the truth. There are a number of ways to take even the lowest credit scores back to baseline, such as ensuring that all payments are made on time, paying off large balances (if possible) and addressing any delinquencies that might exist erroneously. The first step is to pull your credit report—you’ll also want to get your credit score, which can usually be acquired free of charge from banks and credit card issuers.
Although it should be stated that credit repair does take time, it’s far from impossible and is one of the first steps you should take when considering business funding.
Tip #3 Consider Establishing a Separate Business Credit Profile(up to here)
If your personal credit score isn’t exactly where you’d like it to be and it has proven difficult to improve, establishing a separate business credit profile may be one of the best ways to obtain small business financing (although it’s still important to focus on improving your personal FICO score as most lenders use your personal credit score). A business credit card, for example, may not necessarily come along with the best interest rates, but opening one can help you to establish a new credit profile that differs from your personal credit.
Just as with improving your personal FICO score, you can build a business credit profile by making payments on time, catching up on any past-due payments and pulling a report often to look for, and immediately address any errors that might exist.
Additional Factors that Can Affect Approval/Denial
It’s easy to focus on your credit score when setting out to obtain small business financing. There are, however, a number of other factors that can affect your chances of getting either approved or denied for a loan. While working on improving your personal and business credit, be sure to take inventory of the following factors and—if possible—address each as necessary prior to applying for financing:
Tip #4 Industry of Operation
The industry your business operates in is likely something that you won’t be able to change, although it’s important to know that lenders favor financing borrowers in certain industries more than others. If you happen to be in an unfavorable industry try to add products or services that separate you from the rest of the field.
Tip #5 Cash-flow
Cash flow can certainly factor into your ability to get a small business loan. If, for example, you have poor credit but the business is making a lot of money or just has a consistent bank deposits, a lender may be more likely to take a risk on you than if your business had poor revenue and minimal deposits. Be sure to improve your business banking statements as much as you can and document your numbers as thoroughly as possible to ensure you’re able to back up your application. When applying for small business loans most lenders are concerned with your ability to pay back the loan and your current state of affairs.
Tip #6 The Amount of Time Your Business Has Been Operating
Small business owners often find that the longer they’ve been operating, the easier it is to get financed. This makes sense, too, as an established business will have a well-documented track record for lenders to take a look at that can serve as perhaps an even better financial snapshot than your personal or business credit score. While there’s little you can do about this factor if you’re just now starting a business, keep in mind that if you’re denied for financing today, that doesn’t mean you’ll be shut out in the future. Just by remaining in business you are improving your chances of getting business funding day by day.
Tip #7 Current Debt
It should stand to reason why a lender might be leery about financing borrowers who are already knee-deep in debt. Generally speaking, the more debt you currently have following you or your business around, the less likely it is that a lender will be willing to take the risk. The solution? Move some payments around and pay some or all of your current debts as quickly as possible, or at least the debt that is visible on your credit, and wait until you’ve addressed the issue before applying for financing. The lower your debt service coverage ratio (incoming vs outgoing money), the more likely you will be approved.
Tip #8 Business Collateral
Collateral is often a necessary element of getting a business loan, particularly for those who suffer from poor credit. After all, lenders want to know that they’ll have some form of recourse in the case that a borrower ends up defaulting, and for good reason. Business collateral can come in a variety of different forms, such as property owned by the business, inventory and even any outstanding invoices that may exist. The more collateral you have to secure a business loan, the better chances you have of getting approved for a collateralized business loan.
The Bottom Line
Small business financing plays a crucial role in the success of businesses across many industries, whether it be a sole proprietorship with one owner/operator or a company with numerous employees. While having poor credit can certainly stand in the way of obtaining a small business loan, bad credit business loans do exist and can be obtained with a little preparation. These business loans can be extremely helpful in terms of addressing cash-flow issues, purchasing necessary equipment and anything else that a business needs in order to succeed. Take the right steps, and you can work toward financing your business even if you have bad credit.