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Decoding SBA Loan Approval: Key Factors Financial Institutions Consider for Small Businesses

Posted by Lisa Maas on Thursday, December 14, 2023

Creditworthiness, strategic planning and collateral are important criteria in the SBA loan approval process.

A Female Small Business Owner Meeting With A Community Banker To Sign A Small Business Loan

A small business loan can help you cover expenses, purchase equipment, solve a sudden cash flow issue and essentially lay the groundwork for expanding your business. While seeking a loan requires preparation, including research on which loan option is right for you, it's well worth your time. A good place to get started is the U.S. Small Business Administration (SBA). The SBA sets guidelines for loans and offers resources to help your company get off the ground and grow. While the SBA doesn't directly lend money, it provides guarantees to approved lenders like your local community bank, making it more attractive for them to extend SBA loans to your small business.

When a financial institution evaluates your business for a SBA loan, they look at several factors to determine the creditworthiness and viability of your company. In this article, we’ll explain what an SBA loan is and the key loan requirements banks look at when reviewing loan applications. 

The Importance of the SBA

The SBA recognizes that you may face barriers in securing traditional loans. Its loan programs level the playing field, providing you with access to capital and resources needed to thrive. For instance, SBA loans can help you purchase equipment or real estate and can assist with business renovations or acquisitions. The SBA also offers loan guarantees to lenders that reduce the risk, helping lenders extend you credit if you have limited collateral or a shorter business history. SBA loans have other advantages:

  • They offer longer repayment terms.
  • Applicable fees may be financed directly into the loan.
  • Collateral and equity requirements can be less than traditional loan requirements.

SBA Loan Requirements

Lenders, like Northwest Bank, and SBA loan programs have unique eligibility requirements. In general, they are looking at what your business does to receive income and where your business operates. In addition, your company must meet SBA size standards. Size standards are generally based on the average annual receipts or the average number of employees you have. Your lender can help determine whether your business qualifies as small and will provide you with a full list of eligibility requirements for your loan. Here are a few important ones to note.

1. Creditworthiness

Review your personal credit score before applying for a loan. A strong score reflects your financial responsibility and credit management habits. Financial lenders often set minimum score requirements, with higher scores that indicate lower credit risk. A strong personal credit history, marked by timely payments, low credit utilization ratios, and a diverse credit mix, can significantly enhance your creditworthiness. Lenders also look at your business credit score, which takes into account your company's credit history, payment patterns and financial behavior. A positive business credit score shows your ability to responsibly manage credit and meet financial obligations.

2. Business Plan

Every small business needs a well-crafted business plan. A written business plan should outline your business model, target market, competition analysis, marketing strategy and financial projections. Lenders assess this plan to determine your business's potential and the likelihood that you’ll use the loan. They consider your creditworthiness and ability to generate enough profit to repay a small business financing loan based on the 5 C’s of Credit: character, capacity, capital, collateral and conditions.

3. Collateral

Collateral can take various forms, including business assets such as equipment, inventory or accounts receivable as well as personal assets like real estate or savings. The value and types of collateral play a significant role in determining the loan amount and the terms and conditions. Lenders typically seek collateral that has a stable value, ensuring that it can be easily liquidated to recover the outstanding loan amount.

4. Financial Statements

Financial statements, including a profit and loss statement and balance sheet, offer a detailed picture of your business's financial health. The profit and loss statement is a detailed account of money coming in and out every month. The balance sheet is a snapshot of your business’s finances that outlines assets, liabilities and equity. Lenders analyze these documents to help understand your company’s overall financial stability.

5. Debt Service Coverage Ratio

The Debt Service Coverage Ratio (DSCR) provides a clear indication of your business's ability to cover debt obligations with operating income. Lenders calculate the DSCR by dividing the net operating income by its debt payments. A DSCR greater than 1 indicates that the business has sufficient income to meet its debt obligations. Lenders typically look for a DSCR of 1.25 or higher for assurance that your business can comfortably cover its debt commitments.

6. Legal and Regulatory Compliance

Lenders will make sure your business follows all applicable laws and regulations. This includes verifying that you have the necessary licenses and permits to operate legally within your industry and jurisdiction. Not complying with regulatory requirements can come with risks, ranging from fines and legal penalties to business disruptions, which can impact your financial stability. If your business maintains accurate and up-to-date records, meets tax obligations and stays informed about changes in regulations, you may be viewed more favorably by your local bank.

Establish a Banking Relationship

When applying for an SBA loan, it’s a good idea to work with a bank you already have a relationship with. The less risk you pose to a bank or lender, the greater your chance of securing funding at favorable interest rates and repayment terms.

Northwest Bank is an authorized SBA loan lender. If you are considering whether an SBA loan is the right move for you, visit with one of our commercial banking experts to learn more.

The Author

Lisa Maas

Lisa Maas

Director of Government Guaranty Lending

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