Most lenders will require a company to be in business for at least two years before they can get a small business loan as the lender wants to make sure the company will still be around when the loan comes to term, so the lender can recoup their funds. The risk with a company that hasn’t reached two years is that there may not be enough history to evaluate their potential to survive as 20% of new businesses are likely to fail within the first year, and the number rises to roughly 30% by year two.
Companies that have been in business for at least two years show:
- Enough data to display cash flow and fiscal responsibility over a period of time.
- How credit and debt are managed.
- The ways a business reaches profitability.
- Where the business stands now and it allows for a prediction over the next few years.
- A more accurate business credit score and debt to service coverage ratio.
In addition to having more history to show how creditworthy the borrower is, two years in business allows the company to begin building assets that can be used as collateral. But two years is not set in stone as each lender is different.
Some lenders like us only require 6 months in business and the SBA has no time in business requirements, only that you’re operating in the USA, they allow the individual lenders to determine it. The two + years in business model is a common threshold for what the market determines based on alternative or online lenders, as well as credit unions and traditional banks.
If you cannot get approved for a business loan because of the amount of time you’ve been in business, your goal should be to build your creditworthiness. This way you can offset the risk of a lack of history with assets and data to show that your business is a wise investment for the lender to loan money to. Here’s some more information about each of the bullet points above, and alternatives to a business loan if you cannot get approved.
Financial History and Assets
Having a couple of years in business allows time to file two sets of tax returns and displays how fiscally responsible the company is. There will be two four months of data showing incoming and outgoing cash flow, how well accounts receivable is collected, and how revenue has increased and stabilized.
When the lender has this level of information, they get a better picture of the cash available to make payments each month, quarter, or whatever the payment terms are so they can feel confident when providing a loan. On top of becoming stable financially, the business will likely have begun accumulating assets.
Store displays, manufacturing equipment, even computers and office furniture can all be assets used for collateral once they’re owned in full by the company. By using the assets to secure the loan, the business owner reduces the lender’s risk and increases their chances of getting approved. A new company likely will not have had enough time to purchase or pay for enough, but a company with at least two years in existence will have had enough time to start acquiring and owning assets.
Your Profitability and Future Projections
With at least two years of financial data the business owner will be able to more easily find operational deficiencies, growth trends, and create financial projections based on market opportunities.
Business plans that include growth opportunities and how the finances will be used are an important part of a new business getting approved for financing, and this level of data makes it easier for the business owner to be able to both say how the funding will be used and use data to show they are a company that can spend and invest it wisely. One example could be a working capital loan when demand is high but output is stunted due to a lack of resources.
The two years of data will show how adding a missing manager and select employees will allow for increased production to meet the higher demand needs. This same type of small business loan can also be used to purchase inventory or raw materials to produce more goods, and then create a forecast of future profitability with the ability to make loan payments.
Having two years of data lets a business owner know their demographics better so they can begin increasing their offerings if they have a retail store or expanding locations with a brick-and-mortar. A clothing retailer may find out their customer base is women with children, and add in test products for kids like tiny hair ties if they sell hair accessories for women. A restaurant will know what types of foods work depending on who is dining in or getting takeout so they can begin advertising to similar groups of people within their region and grow their customer base.
This is the type of information that the lender will want to see, and without having been in business long enough, it won’t be as accurate or predictable.
More Accurate Business Credit Scores and Debt Ratios
Business credit scores take a while to build and show accuracy as they track debts, payments, credit that is available to the company, and other information. Having two years of regular payments and allowing revolving credit limits to increase can show fiscal responsibility and increase the company’s business credit score.
Having a more thorough idea of what the score is with two years of data lets the lender confirm their decision on companies that are good or bad to lend to. With two years of data the lender can see where they could have made a mistake like a company that starts out with extra debt because they had to buy equipment, but makes on time payments and is the “creditworthy” and fiscally responsible type of company they want to loan too. Examples of what could be considered good after two years in business with 3 to 5 tradelines being reported on are:
- Dun & Bradstreet PAYDEX (0–100) at 80 and above.
- Experian Intelliscore (0–100) at 76 or higher.
- Equifax Business Credit (0–100) above 80.
- FICO SBSS (0–300) for SBA loans and banks should be in the 160 – two 00 range.
Aside from making on-time business credit card, rent, and other monthly payments, see if suppliers will let you pay net 30, then report the on-time payments. After two years of working together and having a strong relationship, they might be open to it to help you out. The other thing to do is work on your Debt to Service Coverage Ratio (DSCR).
Your DSCR is a number that shows a lender how likely you are to be able to cover payments plus interest. It is calculated by dividing your net operating income by your total debt service (principle and interest) and generating a number. 1.0 means you operate a break even, above a 1.0 means you have extra cash and are more likely to make payments, and below a 1.0 puts your business in the higher risk category.
If your business credit score or DSCR ratios aren’t in an ideal place yet, don’t worry, there are other things you can do to make up for the lack of having two years in business and lower numbers.
What You Can do to Get Approved
To increase your chances of getting approved for business loans when you have less than two years in business, try:
- Having vendors and suppliers report on time payments including net 30/60/90 to the business credit bureaus.
- Opening a business checking account or business line of credit with the lender to show you’re looking for more of a commitment and relationship with them while building an immediate financial history.
- Offering a larger amount of collateral or making a larger deposit down.
- Making a stronger personal guarantee on the business loan like an unlimited one or raising the limit on the limited version.
If none of these are an option, newer businesses can sometimes secure funding from friends and family, look for investors, try equity financing, or explore credit-building options like a line of credit. While a business credit card or line of credit may not offer the same amount of financing as a small business loan, on time payments can be reported to the business credit bureaus and help improve your business credit score to improve your chances of an approval.
Lenders will require a company be in business for roughly two years as a general consensus because it gives them enough financial history to make an informed decision on the borrower’s risk level. If you don’t have two years in business but do have strong cash flow or enough assets, some lenders will skip the two years qualification as you may be deemed creditworthy. Others, like us, will loan to companies that have only been in business for six months, so if that’s you, click here and let us know about your financing needs.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
