How to Get a Small Business Loan With Bad Credit

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Opportunity often appears when you least expect it. You've dreamed of expanding your restaurant for ages; suddenly the space next door becomes available. You're prepping your retail inventory for the holidays, and a supplier offers you a discount on the season's hottest-selling toy. Taking advantage of opportunities like these might require getting a business loan. But if you have bad credit, do you have to shut the door when opportunity knocks? Not anymore: Today, there are several ways to get a small business loan with bad credit.

Do I Need a Business Credit Score for a Small Business Loan?

If you've been in business less than a year, you won't have a business credit score, because credit reporting agencies don't yet have enough information about how your business manages debt. Instead, lenders will look at your personal credit score to determine if you're qualified for a loan. In general, traditional lenders (banks and credit unions) want to see a minimum personal credit score of 650 before approving you for a loan, and many require a score of 680 or more.

If you've been in business for more than a year, lenders will consider both your business credit score and your personal credit score. (If you're not sure what your business credit score is, get a free copy of your business credit report to find out.) Traditional lenders will weigh your business credit score more heavily, while alternative financing sources (such as online lenders) focus on your personal credit score and financial indicators such as your business's revenues or receivables.

How to Get Approved for a Small Business Loan With Bad Credit

To get a business loan with bad credit, follow these steps:

  • Check your credit score. Check your personal credit score and your business credit score by getting copies of your credit reports. Review the reports for any errors and contact the credit bureaus to dispute any mistakes you find. Knowing where your credit score stands can help you determine the types of loans for which you're most likely to qualify.
  • Research your options. Look for a business loan that will give you the amount of money you need for the lowest cost and has a repayment term that works for your situation. (Keep reading for more details on different kinds of business loans for people with bad credit.)
  • Write a business plan. Some lenders ask for a business plan as part of your loan application. Even if your lender doesn't require one, writing a business plan is a smart move. If your poor credit score stems from money management problems, having a well-thought-out business plan will help keep you from making the same mistakes with your business finances. You can get free advice on your business plan from expert consultants at SCORE (Service Corps of Retired Executives) or your local Small Business Development Center (SBDC). Do you prefer the do-it-yourself approach? Try searching for business plan templates online.
  • Provide collateral. Putting up collateral can improve your chances of getting a business loan with bad credit. If you can't repay the loan, the lender will take your collateral as payment. Avoid using personal assets, such as your home, as collateral for a business loan. If your business fails, you could end up losing both your business and your home. Instead, choose a loan that lets you use business assets like equipment or outstanding receivables as collateral.
  • Find a cosigner. If you want to get a business loan but you have bad credit, see if you can find someone with a good credit score who's willing to cosign the loan for you. Since this person is guaranteeing they will take over the loan payments if you can't, it's essential to make sure that they can afford to do so and that both of you are truly comfortable with the arrangement.

Types of Small Business Loans for Bad Credit

It's difficult to get a traditional business loan from a bank if you have poor credit. Fortunately, there are many other sources of financing you may be able to use.

  • Business credit cards: Using a business credit card not only gives you access to capital, but can also help improve your business credit score if you make your payments on time. As a result, a business credit card can be a good financing option for a startup business that needs to build a credit history. (Make sure to choose a business credit card that reports your payments to the major credit reporting agencies; not all of them do. You may have to contact the card issuer to get this information.) Since business credit cards have higher interest rates than many other types of financing, they're best for financing small amounts that you know you can pay off in full quickly.
  • Short-term loans: Both traditional and alternative lenders offer short-term loans, which generally have terms from six to 24 months. Instead of a fixed monthly payment, some lenders automatically withdraw payments from your business's bank balance daily, weekly or monthly.
  • Short-term lines of credit: These offer terms similar to short-term loans, except they are revolving credit (like credit cards) rather than installment loans (which require fixed monthly payments). Business owners often turn to short-term loans or short-term lines of credit when they need working capital to pay for expenses such as payroll or inventory.
  • Invoice factoring: Small businesses that have unpaid receivables can turn them into cash using factoring. Factoring companies buy your unpaid invoices from you for a percentage of their value (typically about 80% to 85%). The factor collects payment on the invoices from your customers and pays you the balance of the invoice minus the factoring fees. The value of your invoices, not your credit score, is the primary consideration for factors.
  • Invoice financing: Although similar to invoice factoring, this short-term financing method has some key differences. Instead of buying your invoices, the financing company advances you the value of the invoices. You're responsible for collecting payment from your customers and paying back the loan and any related fees.
  • Equipment financing: Do you need to buy equipment for your business? This type of loan is used to finance the purchase of equipment using the equipment itself as collateral (kind of like a car does for a car loan). This helps to keep interest rates relatively low, although those with bad credit will pay more interest. Equipment manufacturers are the best place to look for equipment loans; there are also third-party equipment lenders, including Currency Capital, CIT and Balboa Capital.
  • Microloans: If you only need a small amount of money (anywhere from $500 to $10,000), a microloan from a nonprofit organization could be the answer. These loans are primarily intended for business owners who live in underprivileged communities or run socially responsible businesses. Your business's goals must also align with those of the nonprofit, such as creating new jobs for people in poverty. Poor credit isn't a deal breaker for microloans; however, the lender may require you to get regular business counseling or take business classes as a condition of approving obtain the loan. You can check out popular microlenders such as Kiva and Accion to find out more about microloans.
  • Merchant cash advance: Businesses that accept a high volume of credit card payments (such as retailers or restaurants) may qualify for these short-term loans for people with bad credit. The lender advances you a lump sum against your business's future credit card sales and then collects a percentage of those sales from you every day. Since payments are based on sales, you won't have to make a big payment on a day with slow sales. However, merchant cash advances have high interest rates and high fees, so most businesses should use them as a last resort.

What to Consider Before Applying for a Business Loan

To improve your chances of being approved for a business loan, understand these key factors before you apply.

Factors that Impact Your Approval Odds

  • Type of lender: Traditional lenders have strict requirements for loan approval. Most require completing a multi-page loan application and providing three years' worth of financial statements and a business plan They'll also look at both your personal and business credit scores, so you'll need a solid business credit history. Getting approved for a traditional bank loan can take months. In contrast, alternative or online lenders typically have much more lenient requirements. For example, they may ask to connect to your accounting software or check your business bank statements. If you meet their criteria, some alternative lenders will approve your loan within minutes.
  • Personal credit score: As we mentioned earlier, 650 is the minimum personal credit score you'll need to be approved for a traditional business loan. However, even alternative lenders have minimum credit score requirements. In general, you'll need a score of at least 500 to qualify for a business loan from an alternative lender; if your score is 600 or more, you'll have more options.
  • Age of business: Traditional lenders typically ask for three years' worth of tax returns and financial statements as part of your loan application. If you've been in business less than three years, you're likely to have trouble getting loan approval from these lenders. Alternative lenders have less stringent requirements for the age of your business; in fact, many cater to fledgling businesses.

Factors to Compare When Choosing a Loan

Ideally, you'll end up with more than one loan option to choose from. To determine the best loan for your business, compare these factors:

  • Loan term: Short-term loans are generally for 24 months or less. Mid-term loans are typically for two to five years.
  • Interest rate and APR: Know both the interest rate and the annual percentage rate (APR), which encompasses the interest rate plus any loan fees or other loan costs. Also take into account the total interest you'll pay over the life of the loan.
  • Loan limits: It's harder to get a second business loan when you already have an outstanding loan. Try to get one loan that provides the full amount you need so you won't have to apply to multiple financing sources.
  • Loan fees: Make sure you understand all the fees involved in your loan. These may include origination fees, underwriting fees, closing costs, late fees and factor fees.

Factors That Lenders Consider

What factors do lenders consider when reviewing a business loan application? Here's what they want to know:

  • Annual revenue: Traditional lenders will examine past years' financial statements to see if your business has a steady income. Online lenders are more likely to approve businesses with lower revenues. Keep in mind that impressive annual revenues can help to offset a bad credit score and make it easier for your business to get a loan.
  • Cash flow: Even businesses with strong revenues will struggle to get approved for a loan if they have poor cash flow. Lenders want to make sure you have adequate cash flow to pay back the loan and still cover your other business obligations.
  • Current debt load: Lenders will assess the amount of debt you're currently carrying to be sure you can handle the additional debt.
  • Business plan: Traditional lenders will review your business plan, looking for a sound business model, a strong management team and realistic financial and sales projections. Alternative lenders typically don't ask for a business plan.
  • Loan purpose: Traditional lenders want to know exactly what you'll use the loan proceeds for and the financial impact the loan will have on your business, such as increasing sales or boosting production.

How to Get a Business Loan With Better Terms

What if none of these loan alternatives provide a loan that fits your needs? If you can't get approved for a business loan that suits you now, don't give up. Follow these steps to help you qualify for a business loan with better terms in the future.

  • Improve your personal credit score: Start by bringing any late payments current as soon as possible and disputing any errors on your credit reports. Pay your bills on time—not just credit card and loan payments, but also your rent, utilities and phone bills. Don't apply for new credit accounts or close unused credit accounts; either of these actions can negatively affect your credit score. Finally, work to pay down credit card debt and other revolving credit; aim to use no more than 30% of your total available credit. Get the details on how to improve your personal credit score.
  • Build your business credit: After you've made sure your business credit report is accurate and brought any late payments current, work on building your business credit by getting credit and using it responsibly. Make sure any business credit cards you use report your payment history to at least one of the three major business credit reporting agencies (Experian, TransUnion and Equifax). See if you can get trade credit with suppliers, and ask them to report to the credit reporting agencies. Even a very low trade credit limit can help: By paying your bills on time, you'll help to improve your credit score and encourage suppliers to extend more credit.
  • Reassess your business plan: Review your business plan to see if there are ways you can cut costs or increase revenues. Either tactic can help reduce the amount of financing you need. You can also ask lenders who turned you down to give you feedback on your business plan. Use what you learn to revise the plan and make it more appealing to lenders in the future.

A Loan at Last

To find out if getting a business loan is a viable possibility for you, get a free copy of your credit report. If your personal credit score is 500 or more, you have more options for business financing than you may have thought. Getting a business loan with bad credit isn't easy, but if you do your homework to find the right loan product, it can be done.