It’s no secret that finding small business financing can be an arduous process. And beyond everything else you hear you need in order to qualify for a loan, there always seems to be that one non-negotiable: a good credit score. While having good credit certainly makes it easier to qualify for a small business loan, it’s time to dispel the myth that you won’t be able to find business financing without it.
In the past, it may have been all but impossible to qualify for a small business loan without a stellar credit history. However, thanks to the growth of online lending, there are now many different loan options available for business owners of all different levels of creditworthiness.
Below, we’ll go over all the basics of applying for a business loan with a bad credit score, including the other factors that lenders consider when deciding whether to approve your business for a loan.
Business vs. Personal Credit
Bank loans are known to be some of the most sought-after small business loans on the market, thanks to their long repayment periods and lower interest rates. However, this also makes them more competitive; banks are known to turn away business owners with bad credit scores, while other lenders may be more lenient.
When you apply for a small business loan through a bank, typically, the bank will look at your business credit score as part of your application. This is a problem for many entrepreneurs; for example, some of them haven’t been in business long enough to have any business credit history at all.
Many alternative lenders, on the other hand, will often consider only your personal credit score when evaluating your loan application. If you haven’t been in business long enough to build business credit, but have a solid personal credit score, an alternative lender just may be the way to go.
If you have a bad personal credit score, it’s still not the end of the road. While a bank loan may not be an option with a low credit score—there are still other options to consider.
What is a “Bad” Credit Score?
There are different tiers your credit score will fall into. Generally speaking, anything above 670 is considered a good credit score on the FICO scale, anything above 740 is very good, and 800+ is considered exceptional. Typically, anything below 579 is considered poor credit—but keep in mind these ranges can vary.
Knowing where your credit score falls in relation to others’ is very important for some lenders, and less important to others. Factors that influence your credit score include the amount you owe currently, your payment history, the length of time you’ve had open accounts, percentage of available credit you’ve used, and the mix of credit accounts you have open.
A bad credit score is not forever—you can work on it and improve it over time by, for example, paying down debt and making all your loan payments in a timely manner. And, if you need business financing before you can improve your score, there are several loan options available (which we’ll get to in a bit).
It is also important to note that, while a good credit score certainly helps with your small business loan application, it cannot guarantee that you will receive the exact funding you want. Now, we’ll go into the other factors that lenders care about when it comes to your small business loan application.
Other Factors in Your Loan Application
While lenders, both traditional and alternative, depend on similar sets of criteria in regards to small business loan applications, their decisions are not completely predictable. No two lenders are the same, and there is no guarantee that you’ll qualify for the exact loan you want, no matter how strong your application is.
That being said, here are the most important factors when it comes to your business loan application:
- Current Debt: If you’re currently deep in business debt, many lenders won’t want to work with you because there is a risk that your other debt obligations will prevent them from being repaid. If you already owe another lender, that puts them in second position. If you go bankrupt and your assets are liquidated, your original lender will be compensated for your outstanding debt first, but the second position lender will not be until the first position lender has been repaid in full. Of course, existing debt is not a complete deal-breaker, especially if your business financials are healthy otherwise. But no matter which lenders you apply for lending through, be prepared for some lengthy talks about your existing debt.
- Annual Revenue: Business lenders want to see that your business is bringing in enough money each year to cover your loan payments. Plus, knowing your annual revenue means you have some set expectations when it comes to your loan amount.
- Cash Flow: Lenders will most likely ask to see a few months of your business’s bank statements with your loan application. Again, they want to make sure that you are making and keeping enough money each month to be able to repay your loan.
- Financial History: Most lenders will pull up your detailed credit report as part of your application. Even if they work with business owners with bad credit scores, they will want to know why your score is bad. For example, bankruptcy is not necessarily a deal-breaker, but they will at least want to see that you are a few years out. Other red flags would be a tax lien or foreclosure, but don’t panic—lenders offering bad credit small business loans may still work with you.
Bad Credit Small Business Loans
Finally, let’s go over the various types of small business loans for bad credit. Keep in mind, even if you think your credit score is too low, you may still qualify for a term loan or an SBA loan—it doesn’t hurt to try. That said, if your score really is too low, one of these may be your best option:
- Collateralized Loan: One way to offset a bad credit score in securing business financing is to offer the lender something as collateral. Invoice financing, for example, is something you may qualify for if you are unable to cover business expenses while waiting for outstanding invoices to be filled. Equipment financing is a good way to finance a piece of equipment for your business, and it puts the equipment itself up as collateral until you pay it off.
- Short-Term Loan: Short-term loans have the familiar structure of traditional loans, but on a shorter schedule and typically with a higher interest rate. Generally, these loans are repaid in daily or weekly ACH payments within 3-18 months.
- Merchant Cash Advance: Merchant cash advances are what most people think of when they hear the term “fast cash.” You are given a lump sum of cash up front, which you then repay with a set percentage of your future sales—typically through your daily credit card sales. That means you don’t have a set repayment schedule and pay more when business is doing well—and less when it’s not. However, be aware that this type of financing is very expensive and does interrupt your usual cash flow.
Qualifying for a business loan with bad credit is tough, but not impossible. If you want to improve your credit score before you attempt a loan application, start now. Pay all your bills on time, build up your bank balance, get a business credit card to help you build credit, and continue monitoring your score. Keep plugging away and you’ll get there!
If you need help sorting through your personal finances to help you prepare financial for success as a small business owner, contact a nonprofit financial coach today!
About the Author:
Meredith Wood is Editor-in-Chief at Fundera. Specializing in financial advice for small business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.