Keep this list in mind, it comprises the most important factors in your business loan application process
- Credit Report
- Equity Injection and Reserves
- Closing Items
If you are planning on starting up a business it is important that you realize how important it is to have strong personal credit. Whether your business is your own idea or part of a franchise, it is considered a start-up if you have never owned or operated this particular business in the past. When there are no historical financials for a lender to evaluate for the business (corporate tax returns, profit and loss statements or balance sheets) the personal credit reports of the owners of the business or those applying for the loan are looked at carefully. For an SBA loan, all owners of 20% or more of the business must meet minimum qualification criteria.
There are 3 credit bureaus used to evaluate the credit of an individual. These bureaus are Equifax, Experian and TransUnion. Each lender may use any or all of the above to check an applicant’s credit. It is wise to check your own credit before applying for a loan. There may be an error, late payment, dispute or collection that you have forgotten about or do not realize is there. It is also possible that any of these entries are a mistake. It is best to know exactly what is showing on your reports well before applying for a loan. It can take several months to get mistakes corrected or to have past items removed that should no longer appear on the reports. A good way to pull full credit reports with scores from all three credit bureaus is: https://www.freescore360.com/
Pulling reports on your own prevents unnecessary inquiries and will not decrease your score during the pre-qualification stage of your loan. When you click to print the reports, just select to “print as” Adobe PDF and save the files on your computer so that the attachments can be shared with your Business Financing Advisor or Business Loan Broker. These consultants can be extremely helpful in guiding you through the loan process and in finding the right lender match for your project. In particular you will want to know your scores on each bureau, whether there are late payments or accounts in collections or disputes showing and your overall revolving credit usage percentage.
SBA lenders like to see revolving credit usage percentages below 30 to 40% and scores of 675 or higher across all three bureaus. Some lenders require credit scores of 700 or higher. Others will allow slightly lower scores if other factors in the file are positive. Overall credit usage is figured by dividing your total amount of revolving credit owed by the total revolving credit limits of all cards. For example, if you have 3 credit cards all with available credit limits of $10,000, your total available credit would be $30,000 (or 0% revolving credit usage) if there were a zero balance on the cards. If you have a balance of $5,000 on each of the three cards you would owe a total of $15,000. This would be considered revolving credit usage of 50% ($15,000 owed out of the $30,000 credit limit is 50%). This is slightly too high for some SBA lenders to approve a business loan application. As the percentage of revolving credit usage goes up, it tends to cause a drop in the credit score.
Many people close credit cards when they are not being used. This can be a bad idea if you are attempting to keep your credit scores high and your credit usage percentage low. If you have a credit card with a limit of $10,000 and there is no balance on the card, this helps your overall usage percentage when you have balances on other cards. If there is not a yearly fee for the card, you should use it once in a while and pay it off to keep the account open and to increase your overall available credit limit. As revolving usage (balance owed) is paid down, your scores will increase. Sometimes it takes a billing cycle or two to show a change in the score. If you make a large payment on a card or pay the balance in full, it is a good idea to file a dispute with each bureau (can be done online at each credit bureau) and let them know you would like an immediate update as the balance has been paid in full. This usually helps the bureaus update your scores more quickly than if you did not file the disputes.
Building credit and cleaning up reports can be tedious and extremely time consuming. If your scores are very low and you have a past bankruptcy, delinquencies, accounts in collections and/or late payments it would be a great idea to contact a credit repair agency to get professional advice and help on what steps to take.
Household income is another important aspect of what is considered when applying for a business loan. In addition to strong credit, lenders will evaluate a borrower’s last 3 personal tax returns to look for stability and growth. Income and credit are inter-related. Lenders will look at the debt to income ratio to determine the likelihood of the borrower having the ability to pay his or her current monthly obligations as well as the new business loan payment. SBA lenders all have their own regulations with respect to the debt to income ratio that will secure a loan approval. It is tough to provide an exact number for this because several other factors are also taken into consideration. It is extremely helpful if there is a double income (if an applicant is married and spouse shows W2 income) in the household. Many times a borrower that is starting a business will be planning to leave his or her position of employment. Lenders will want to know that stable income will be remaining (even if the amount is lower than it may have been in the past). A working spouse will help overcome the problem of the temporary income loss or decrease while the business is ramping up.
Keeping employment for as long as possible while the business is ramping up is a good plan. If a new business owner has plenty of savings or reserves and there is other household income, this may not be an issue. In many instances this is not the case. Underwriters will feel more comfortable in providing an approval for a loan in which a borrower plans to keep his or her existing employment while the business is starting up. If there is not additional spousal income and the business owner must leave employment, a borrower should plan to have plenty of reserves in savings and investments to show that it will not be a problem to continue paying monthly obligations and the new loan payment.
Borrower Equity Injection and Reserves
Start-Up Business loan applicants should plan to have cash in accounts to cover the expected equity injection that will be required by the lender. Most SBA lenders will require an equity injection percentage of 10% to 30% of the total project cost or the total loan amount to be put in by the borrower. The percentage expected will depend on the lender, type of loan, loan amount, industry and financial portfolio of the borrower. Additionally, underwriters will want to see that the borrower also has additional savings or reserves in checking, savings, stocks, bonds, retirement accounts or other liquid assets. The reserve amount expected will depend upon the loan amount, the equity percentage, the lender, the type of business loan, the loan amount, the industry and the past business management experience of the borrower.
A person starting up a business may claim that they have already spent funds and put money into the business prior to applying for the loan and want these expenditures to count toward the equity injection. The applicant should expect that a lender will likely only accept single purchases of $500 or more with documented receipts to count toward the equity injection required for the project. Meals, travel expenses, entertainment or things of this nature may not be permitted unless there is documentation that these expenses were part of travel and/or accommodation for franchise training or licensing.
Depending on the lender, loan amount and equity injection of the borrower, collateral may be required. Collateral is something that helps secure a loan. When you borrow money, you agree that your lender can take something and sell it to get their money back if you fail to repay the loan. Collateral makes it possible to get large loans, and it improves your chances of getting approved if you are having a hard time getting a loan. Collateral is usually in the form of a real estate asset or cash. Cash collateral can be a payment reserve (12 to 18 months worth of loan payments kept on file for a period of 2 years) or a CD kept for the term of the loan at the bank providing the loan. Another option for collateral is the assignment of a life insurance policy to the bank offering the loan. A whole life insurance policy (on the borrower) that has cash value is sometimes used as a pledge of collateral. To read more about collateral: https://keycommercialcapital.com/what-is-collateral/
Texas is the only State that does not allow a borrower to pledge the primary residence as collateral for an SBA loan. Texas is a homestead State and will not allow creditors (except the holder of the mortgage, a taxing authority, or the holder of a note for a home improvement loan) to force the sale of a primary residence to satisfy nonpayment of debt. For this reason it is not permissible for the primary residence in Texas to be pledged as collateral for an SBA loan.
One of the first few steps in getting a pre-approval for an SBA Start up loan will be the correct completion of the Personal Financial Statement. This is the SBA 413 form. It is essential to provide accurate information on the form as the numbers on it are used by the underwriters to analyze your file. If your loan is approved, you will be required to provide verification for everything that was listed on the form. Lenders understand that checking and savings account balances might go up and down daily. An exact dollar figure is not required as long as the numbers are close to the balance you will have when underwriting reviews your file. You will be required to provide three months statements for all checking and savings accounts and a monthly or quarterly statement for all retirement accounts, stocks, bonds or other investment accounts.
A copy of the last three years of personal tax returns will also be required. If the full tax returns with all schedules and pages can be provided, it will speed up the underwriting process. The 4506T form is one that you may be required to sign. This form allows the bank to pull the personal and/or corporate tax return transcripts directly from the IRS. Many lenders require the direct transcripts from the IRS to double check the numbers on the returns submitted by the borrower. Although foolish, I have seen a borrower embellish the copy of a corporate return. The loan got approved based on the copy submitted, but when the transcripts came in from the IRS the corporate return numbers were completely different than the copy submitted by the borrower. Of course this was viewed as fraud and the loan in closing was immediately declined.
One of the other items needed in order to submit a formal application for an SBA loan will be a worksheet outlining the total project cost and an itemized value breakdown of what categories or items make up the total cost. Examples of these categories are as follows: franchise fee, territory fee, equipment, inventory, working capital, lease costs, construction costs, etc. Additionally, most lenders will require a one to three year projection spreadsheet estimating monthly revenues and expenses. Some lenders will also require a detailed business plan explaining how the daily operation of the business will function. Business plans will also include an explanation about area research, target market, estimated costs and responsibilities of owners, managers and staff as well as discussion about marketing/growth plans and the general daily operations.
Other items required for documentation might be a copy of your mortgage statement and homeowner’s insurance policy. If the business is operating out of a home office there will also be a flood zone search. If the home is located in a flood zone, the lender will also require flood insurance as per the SBA. If the business will be leasing a space, it is a good idea to find out whether or not the building is in a flood zone. If it is, flood insurance will be required as per the SBA.
In addition to the above documentation, the borrower will need to provide a number of other items prior to the closing of his or her SBA loan. If the State requires a business license for the state or county for a particular industry, a copy of the license must be provided prior to closing. If the business will be leasing a space, a copy of the signed lease agreement and possibly a landlord subordination agreement will be required. Depending on the lender and the type of loan the landlord might be required to sign a release allowing the lender the first right of asset seizure should there be a loan default. Additionally, the landlord might also be required to sign a form stating that the business will be allowed the option of renewing the lease for the term of the loan. This does not mean that the business must stay in the location for the term of the loan. It simply means that the landlord must provide an option to renew for the term of the loan if the business chooses to stay. This is not essential for all businesses. It will depend on the nature of the business and the industry. Some lenders will waive this requirement if the business can show that it can function in any space and that its revenues are not dependent on any particular location. Many non-retail or service-based businesses that perform the work in the homes or business locations of their clients will have this requirement waived. Other closing items will be copy of Driver’s License, copies of business general liability and property insurance policies, copies of all State documents with respect to legal business names, dba names, operating agreements, articles of organization or incorporation, bylaws and the SS4 form from the IRS showing EIN.
If the start-up business will be a new franchise territory, the lender will require copies of all signed franchise agreements and documents. If the business is a franchise and an SBA loan is being requested, the franchise must appear on the SBA approved directory. A borrower can easily check to see if the franchise of interest is on the approved directory list by going to: https://keycommercialcapital.com/sba-franchise-directory/. The information on this page is monthly as the SBA list is updated. It also offers a convenient search feature. The name of the franchise can be typed into the field and all related names will be displayed. This is much easier than scrolling through multiple pages of the list of over 3000 franchises.
Please note, all of these items are part of closing, not part of the underwriting or approval process. If you are working with a reputable SBA preferred lender you will be given a commitment letter once your loan is approved. This is a firm commitment by the lender that your loan has been underwriting approved and will close once all closing checklist items have been received. When a borrower has this commitment letter in hand, he or she can feel confident to move forward to sign franchise agreements and lease contracts. We encourage all of our clients to obtain this commitment letter prior to signing contracts.
A start-up business does not have to be a franchise to be eligible for an SBA loan, but it does provide for an easier approval. A franchise concept that has been around for several years with success, documented profits and growth can provide a level of comfort for underwriters when considering a loan application. You can find out more about a franchise by examining their FDD (Franchise Disclosure Document). The experience, support structure, business organization model/road map and training provided by a franchise are all helpful to ensure the likelihood of success of a new franchisee. Nevertheless, if a start up business is not a franchise, it is still eligible for SBA financing as long as it is not any of the following: speculative businesses (real estate investment firms, collectables of rare stamps, coins, etc. ), lending or loan packaging companies, non-profit businesses, pyramid or MLM’s (multi-level marketing schemes), gambling organizations (racetracks, casinos, etc.), religious institutions, or a government-owned business.
Key Commercial Capital is available to assist clients during each step. We are able to provide links to help a new business owner register the legal business name in their State, to file DBA and to obtain the SS4 form with EIN from the IRS. We help applicants prepare their files for an easy approval and introduce clients to the right lender to fit the specific project. We do not charge an up-front fee for our services. We are committed to working hard to get a commitment letter from the right lender for your business loan prior to invoicing for our services. If your file does not get an approval, we do not collect a fee. Additionally, we can assist and coach you through edits to your business plan and your business projections for a favorable outcome. Once you receive an approval we continue to be available throughout the closing process to help you understand the closing checklist items and to provide advice on any uncertainties. Borrowers often feel uncomfortable or leery to share details or to ask too many questions when communicating with lender staff. You can rest assured that your details are kept confidential. We are happy to be the mediator between you and the lender to be sure the loan can fund with the least amount of issues or delays. Please contact us today with any questions.