One of the primary ways through which small business owners access massive funding to run their business is through a business line of credit. Unlike other types of loans that provide bulk sums over the long-term, you will be receiving a revolving credit line. You can use such funding to take care of your short-term business needs, pay it back and access another business funding immediately.
Would you like to take advantage of this type of business funding? Let’s delve into the details. One of the first things you should know is that the requirements of business loans and business line of credit are not the same. Besides, the prerequisites also vary from one lender to another. Below are some data that lenders take into consideration.
- Your personal credit score.
- The credit score of your business.
- The debt-to-income ratio of your business.
- How long your business has been existing.
- Annual turnover of your business.
- The business sector of your company.
Here are the details about the requirements that give you an edge while seeking a business line of credit from lenders.
The Requirements for Business Line of Credit
There are multiple factors that lenders consider when you apply for a business line of credit. Bear in mind that lenders are not sentimental; they will want to make sure that the funds they are given out will be paid back. That is why it might be challenging to obtain a business line of credit if lenders consider your business “high risk.”
Once the lenders decide to offer credit to your business, they proceed to determine the interest rate using a risk-based pricing model. This model provides a lower interest rate to the businesses that are likely to make repayments on schedule.
Although the requirements for offering a business line of credit differs among lenders. Below is a breakdown of the most critical factors.
Your Personal Credit Score
Perhaps you are wondering why your personal credit score is an essential factor. After all, it is your business that is borrowing funds. The reason is that the business line of credit does require that you guarantee the loan to your business. In essence, if your business fails to repay the loan, you have to take the personal responsibility for repaying the debt. That is why lenders check your personal credit score to ensure you can guaranty your business loan. So, you should aim at getting a FICO credit score of at least 670 or better. You can determine your FICO score by using free services such as Discover Credit Scorecard or Experian
The brighter side of this approach is that your personal guarantee can earn your company funding, even if the credit scope of your business is insufficient. However, funding options would be limited and the interest rate might be on the high side as well.
The Credit Score of Your Business.
Most lenders will not only scrutinize your personal credit, but they will also check your business credit score and other reports about your company. The lender reviews your credit history and uses the information to determine the risk involved when they lend to your company. On the other hand, lenders can base their decision on your personal credit score alone in scenarios where your business is relatively new or does not have a credit history.
You can evaluate your chances of receiving a business line of credit by using Nav to check your business credit scores and credit reports. The Nav utility queries databases from Dun & Bradstreet, Experian, and Equifax to bring you accurate figures.
The Debt-to-Income Ratio of Your Business
Besides checking your business and personal credit scores, the debt-to-income ratio of your business is another essential factor that lenders scrutinize. They arrive at this figure by computing the ratio of your total monthly business revenue and debt repayment obligations. If a high percentage of your business cash flow goes satisfying debt obligations, lenders will be less willing to approve subsequent loans. Although some lenders will still offer a business line of credit to companies with up to 50% debt-to-income ratio, it is advisable to maintain this figure at 36% or less.
The debt service coverage ratio is another metric that lenders check before deciding to offer credit to a business. They arrive at this figure by computing the net operating income in a year against the total debts payable within the next 12 months. The value of 1.25 or better is good enough for most lenders to approve credit for your business with favorable terms. Some lenders might give approval for a lesser score, but the conditions they offer might not be the best around.
How long your business has been existing.
Lenders consider the duration a business has been existing as an essential factor due to the high bankruptcy rate of small businesses. Data have proved that about 33% of small enterprises liquidate before the second year, and only half of the small businesses make in beyond the five years. Based on these facts, lenders are often unwilling to offer payment terms that span beyond five years. They are also cautious while lending to new businesses that don’t have a track record.
Although the duration in business requirement varies among business lenders, many prefer to deal with companies that have operated for at least two years. Some lenders are can still give a business line of credits to newer companies, but such lenders are hard to find.
The Annual Revenue of your Business.
Besides knowing that your business has been operating for years, lenders still want to be double sure that you can take care of your monthly repayments. That is why they check the annual revenue of your business.
Just like other lending criteria, the annual revenue varies considerably among lenders. While many online lenders set the annual revenue benchmark to $50,000, many traditional business lenders would like to see higher revenue figures. Some lenders might even demand that you show your tax returns over the last two years. They want to be sure that your cash flow is strong enough to handle your business line of credit repayment obligations.
The Business Sector of your Company
Some business sectors are regarded as risky industries because they have a high tendency to produce failed businesses. Industries such as retail, restaurant, insurance, and financial services fall into this category.
However, an entrepreneur who has a record of running a successful business in any of the high-risk sectors stands a better chance of funding approval for a new business. On the other hand, a new entrepreneur in such a high-risk industry will have a hard time getting approved for a business line of credit. Lenders that oblige will likely offer fewer options.