Securing a small business loan isn't always easy. Banks typically only lend money to established businesses with solid sales and strong credit profiles. The U.S. Small Business Administration (SBA) has money to lend, but funding can take weeks to arrive. That leaves alternative lenders as a viable option for businesses that need money relatively quickly. Alternative lenders offer small businesses a variety of loans, boasting fast funding and easy approvals. But even they can put you through the paces. After all, granting loans is about determining risk. If lenders think the risk is too high, they're apt to walk away.
To assess how much risk you may carry as a borrower, lenders will ask you a series of questions. Your answers will determine whether you can get a loan and which one is right for you. With that in mind, here are seven questions lenders typically ask potential borrowers, and the reason behind each one.
1. How much money do you need?
This might seem like an easy question to answer. But many business owners have only a general idea of how much they need, without being sure of the exact amount. What's worse, many don't have a clear idea of how much they can afford to pay back. If you borrow more money than necessary, that can turn into a dangerous situation. Before you approach a lender, figure out how much money you truly need. Make sure your monthly payments won't negatively impact cash flow.
The amount you want to borrow will also help lenders determine the right loan for you. If you're covering startup costs of less than $50,000, a microloan may be the best option. If you need a larger amount of money to purchase equipment, equipment financing might make more sense.
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2. What do you need the money for?
There are many reasons small business owners need to borrow money. Some seek a short-term loan to cover a cash flow issue or to purchase extra inventory. Others want a long-term loan to bankroll an expansion. Lenders ask this question to match you with the right loan product. Many options exist, with varying terms and interest rates. When you tailor your loan to a specific purpose, it can lower the cost of borrowing and increase the chances that you'll be approved.
For example, take a small business owner who needs money for a longer-term project. The SBA's small business loans provide low interest rates and long repayment terms. The paperwork will be more arduous than it would with other types of lenders, but it's a better bet than borrowing against your invoices.
3. How will you pay it back?
Lenders want you to pay the loan back plus interest, and will go to great lengths to ensure you can. That is why they require you to prove you can afford the loan. That means demonstrating that you have enough assets, cash in the bank, and/or collateral to cover the loan, even if your business runs into trouble. When assessing creditworthiness, lenders will also take current loans, past loans and other business debts into consideration.
4. Do you have enough cash flow to service the loan?
Being able to afford the loan on paper is one thing, but making the monthly payments might be another. Lenders want to ensure you have enough cash flow to service your loan. Businesses that make a profit have a better shot at getting affordable loans than those that don't. [Related: How to Avoid Cash Flow Mistakes]
5. What does your personal credit look like?
Unless you've been in business for years, chances are your company does not have its own credit score. Even if it does, that score may not be enough to satisfy lenders. That's why most lenders will inquire about your personal credit when underwriting your loan. They want to make sure you don't have too much debt outstanding and that you have a history of paying your bills on time. Your personal credit score usually dictates if you get approved for small business funding and at what interest rate.
If you have been in business for years, have recurring revenue, and have a strong credit score, you'll do best with a bank. If you are just starting out or have questionable credit, there are many non-bank lenders willing to work with you. For example, in our review of SBG Funding, we found that it only requires a credit score of 500. Keep in mind that alternative lenders will charge you more for the increased risk.
6. How are you backing the loan?
Depending on the type of loan and the lender, you may be required to offer up collateral. Lenders figure the more you stand to lose if you default, the more apt you are to repay the loan. Collateral can be paper assets, such as stocks and bonds, or property, such as real estate, vehicles or equipment. If your lender requires collateral, ensure you understand the requirements and inherent risks before agreeing to the terms.
Even when lenders don't require collateral, they often want a personal guarantee. That means they can collect from you personally if the business doesn't pay the loan back.
7. What makes your business different?
Lenders want to know more than your elevator pitch. They want to make sure your business is viable. As a result, they will ask you about your business, what makes it different from its rivals, and how you plan to succeed and grow. Not only does this help in the underwriting process, but it also helps lenders determine the right loan for you.
Small business loans play an important role in helping the nation's business owners survive and thrive. While the cheapest loans are reserved for business owners with solid financials and credit profiles, there are many options for everyone else. If you understand what the lender expects from you, you'll be better able to find the right loan type and provider.
Tom Gazaway contributed to the writing and research in this article.