How do lenders determine which type of funding options you qualify for?
As the criteria used to evaluate a business varies widely for a given financial institution, your individual qualifications may be suited to funding options in one or more of these 4 basic categories:
- Credit – All lenders will review your personal credit score to evaluate lending options. Loans based on credit profile alone are unsecured loans, as they typically are evaluated just on individual credit-worthiness, and may carry high interest rates.
- Cash Flow – These funding types are influenced by the amount of your monthly revenue, the payment frequency and consistency of the cash flow. Funding based on cash flow may have repayment based on daily sales and could fluctuate based on the business daily revenue. This type of funding provides flexibility to the business, but may also have high interest rates.
- Collateral – Funding here uses collateral (either property or other assets) to secure the loan. In the event that the borrower fails to follow through on the lending terms, the lender has rights to seize the collateral. Using collateral to secure a loan will typically result in lower rates than unsecured loans, offering borrowers more manageable repayment terms.
- Chronology (Time in Business) – Lenders evaluate businesses based on their longevity, as the longer a business has been running, typically there is less risk associated with the loan. As a general rule, traditional banks will lend to businesses that have been established for two or more years. Loans based in this category may require extensive criteria to evaluate a borrower, but ultimately result in low interest rates with longer repayment terms.
How should businesses evaluate which loan option is best for them? Understanding your own profile and business needs will help you set the right expectations for your lending opportunities. Next, examine your business priorities by asking the following questions:
- What are your immediate needs – do you need funds tomorrow (or yesterday)? This is critical to lending, as certain loan types may take longer to secure. If you need funds immediately, it may limit your options, although there are still plenty of short-term/immediate funding types.
- What collateral can you put down to back a loan? Collateral can include personal assets, such as a house, or business assets such as buildings, equipment, vehicles, etc. Using assets from the business are preferred, but if you’re just starting out, using personal collateral (real-estate), may be a suitable option.
- How long have you been in business? If you have good credit, collateral and sizable cash flow, along with managing your business for longer than 2 years, you’re more likely to secure a traditional bank loan.
- What is your credit score? A credit score of 680 is generally the cutoff for credit based lending. If you have over 720, you may have a chance to secure funding with lower interest rates, or better terms.
- What are you using the funds for – to buy capital equipment, support hiring, etc? Providing this information to lenders will help them to understand your financial needs and assess which loan type might be suitable to your immediate business needs. This will also help your lender understand your business, and build a relationship that could set you up for better lending options in the future.