There are several factors that typically are considered when a credit team is reviewing a business profile to issue a decline or approve decision for financing equipment or providing working capital. There is some flexibility among lenders when considering the different factors but there is a common base that many work from. The lenders with stricter and tighter guidelines are normally the ones offering the lowest rates so they have a narrower risk profile for each decision. The more flexible lenders, which means the ones able to work with higher risk clients, have higher rates; they win some, lose some (client defaults) but are able to maintain their return-on-investment profit margin.
Following are the basic factors to be aware of so you know where you fall and if there are too many red flags then you can decide not to apply for financing and go a different direction. Learning and preparing in advance will help you understand the process so at the end of the day you don’t throw up your hands and say, “Why didn’t I get approved?” These are only general guidelines and exceptions can be made but somehow they will always have to minimize the risk to the lender.
Factor 1: Time in business. This is the easiest to verify since the secretary of state where you live will have the registered business file; you should check and make sure you are in good standing and active. Less than two years puts you in the ‘start-up’ 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 medium range and still requires the owner’s personal guaranty and over five years in business is the ‘established’ category and can get approved without an owner’s guaranty with borrowing amounts only limited by the business’s performance.
Factor 2: Personal credit. For businesses which have to personally guaranty, the owner’s credit score is very important; particularly the younger the business is. Poor, damaged or low scores indicate how the owner might operate his/her business and is a strong indicator of success or failure and potential default. If your credit has issues, a credit repair service should be the first step before applying for any financing. Most credit repair takes at least three to six months.
Factor 3: Cash flow. Bank balances in your business account, personal account, and savings have to be adequate to pay for the new debt along with enough cushion 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 lots of money. Underwriters are looking for cash influx and reserves that can cover business slowdowns, emergencies, etc. The amount needed will depend on the amount you want to finance.
Factor 4: Comparable borrowing experience. Credit looks to see what you have financed in the past; for newer businesses your personal borrowing will come into play. Car loans, home loans, credit cards and similar will be important to see how those have been managed. As a business gets older you will 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 bureaus underwriters use to review business history. Judgements, liens, pending lawsuits and slow pay history is revealed in these reports. You should request a copy and work to rectify any issues and if a settlement is in the works then a letter validating that should be on file. Credit will always consider a good story to support any issues as long as you have strong documentation. Open liens should be worked on and settled since very few lenders will approve any business with open liens.
There are many other factors a credit analyst will consider but these five are the backbone of most credit decisions. You don’t have to be optimal in all five to get approved but at least two of the five have to be strong. If not, some lenders will allow a family member to co-sign as a guarantor on the loan which normally is a last resort for business owners. A co-signor might allow you to get approved but you still will fall in a higher risk, higher rate category. Overall, you should evaluate where you rate, fix what you can and if you decide to move forward in applying for financing at least you will be better prepared for the outcome.