What You Need To Know About Small Business Lending

Small businesses are the lifeline of the US economy.

Sounds like a hyperbole? The data indicate it’s not.

With their number quickly approaching the 30 million mark, small businesses currently account for more than 99% of all US businesses.

Small business growth is tantamount to US economy’s growth as over 56 million employees work in small firms and more than 1 million jobs are added every year by small enterprises.

Growth predicaments

Capital shortage is the number one reason small businesses fail to grow. Without sufficient capital, it’s hard for a business to expand and increase its revenue.

Unlike their large counterparts, small businesses cannot rely on seed funding. Venture firms rarely invest in small companies as the ROI is admittedly not impressive. Sometimes, small businesses bootstrap themselves, but most of the times it’s not a viable solution as the founder of the business risks ending up bankrupt.

Enters small business lending

Small business lending offers a solution to the capital shortfall problem. Taking a loan allows a business to open new branches/storefronts, hire talented employees and spend more marketing dollars. Some business owners are understandably against borrowing money as they fear paying it off would be difficult. Also, young startup owners who are burdened with student debt hesitate to take a loan for obvious reasons.

However, small business lending is continually growing. In 2013, the share of the small business loan was only 22%. Take a look at the info graphic below:

Today, more than 70% small businesses use financing and the money flowing to these businesses from banks is nearly $600 billion. Stats are provided by the US Small Business Administration.

Sources of funding

The two most predominant sources of the small business loan are bank and credit card. Around 31% of small businesses depend on a bank loan and the same percentage of businesses depend heavily on credit card loan.

Nearly 17% of small businesses borrow money from their friends and family. The SBA offers financing schemes but such schemes are not very popular. Only 3% go this route. A small business needs solid advice on getting a loan from a bank or a financial institute.

Understanding eligibility criteria

For a small business, getting a loan request approved is not a linear process. A business must be eligible to get a loan. Banks and other lenders enforce several eligibility criteria and simply meeting the criteria may not be enough for a business. Muhammad Ali, a financial expert explained it by saying “Most banks have an income eligibility threshold of 1.25 times your expenses, including the repayment amount. Even if you do meet the requirements, think carefully before taking on the loan, and be sure you can service the repayment terms.”

To give you a generic idea, below-listed eligibility criteria are imposed by lenders:

  • The business must have a stable revenue source. It indicates the business is well-off and able to pay off the loan.
  • The business should be able to articulate why it needs a loan.
  • The business owner must have a decent credit score.

All these are basic criteria. If a business fails to meet them, it’s nearly impossible for it to get a loan. Below you can find more specific criteria for small business lending and how these requirement vary from one financial institute to another.

Bank loan eligibility criteria

Bank loan approval rate for individuals is not very high. Over 75% of loans approved are disbursed to people whose credit score is 750 or above, according to BankBazaar.com. Business lending requirements are more stringent than personal lending.

In order to get a SBA backed bank loan, a business owner needs to have excellent business credit besides outstanding personal credit. The average operating capital borrowed by small firms is $25000 whereas SBA loan size can be more than $350000. But to qualify for SBA loan, a credit score of at least 680 is needed.

There’s a threshold of yearly revenue to get qualified for a bank loan. For SBA backed loans, its range is between $25000-$150000. For non-SBA backed bank loan, the revenue could be as high as $200000-$500000. You need to show the business has been operational for more than a year. You also need to show them proof that you are capable of paying off the loan amount and the interest.

Other options

What if a small business is turned down by banks? It can then turn to microlenders, online lending agencies and even to alternative lenders who lend money to people whose credit score ranges from 500 to 600.

Keep in mind microlenders may overlook a not-so-good credit score, but need you to show them a constructive business plan and financial statements. Besides, don’t expect microlenders to lend you more than $50000.

Online lenders, especially the ones that have no physical address may be scam artists, so tread carefully. Also, they give a loan at a really high annual percentage rate. However, to grow your business, you gotta do what you gotta do.

Summing up

As was mentioned earlier, small businesses are the backbone of the US economy. And small business lending is continually growing. If you run a small business and feel you need to lend money, go for it and don’t hesitate. Just be careful and play by the rules.

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