How to get a small business loan with bad credit

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Bad credit doesn’t have to make your business unbankable. The Ascent shows you how to get a small business loan even if you have bad credit.

Our local convenience store recently closed for a few weeks for renovations. When it reopened I was pleasantly surprised to find self checkouts available. The time it takes me to pick up a Diet Mountain Dew has been cut by at least half. My dentist couldn’t be happier.

Businesses are doing everything they can to automate processes and banks are no exception. Many banks underwrite all loans below a certain amount (sometimes the amount reaches $1 million) with algorithms – even banks that don’t have to deal with more and more regulations from the Federal Reserve and the FDIC.

The result is that it’s harder than ever (relative to interest rates) to get a traditional bank loan if you have bad credit. Read on to find out how bad credit affects your creditworthiness and what you can do about it.

Overview: How does bad credit affect you getting a small business loan?

There are two types of credit that banks will underwrite for business loans: business and personal. Personal credit is easy; they’ll pull a personal credit score, and if it’s below a certain number (usually around 670), they’ll decline the loan or ask for an explanation. Business credit is more difficult.

Having poor business credit can mean anything from an uncollectible debt service coverage ratio to poor business credit.

For any business loan, you will go through an underwriting process. Gone are the days when you could get a signature loan from an old friend in two days. Banks will look at your financial history and current leverage, personal finances, competitive position, management experience and analyze your collateral. If there are any issues with any of these, you will need to figure out how to fix them.

Many banks will compile a commercial credit report as part of the underwriting process. Corporate credit reports are widely derided by business owners. The company I work for generates over $1 million in net revenue per year and always pays accounts payable promptly. Yet we have a bad business credit rating.

We are a general contractor and have a pay-as-you-go policy that is communicated to all of our sub-contractors. We do all the government work, which sometimes means we get paid six months after the job is done — that’s when our contractors get paid as well. It only took two subs with big contracts to report that we paid late to screw up our score forever.

If your bank does a commercial credit report, make sure you know what’s on it and have any negative information answered.

How to get a small business loan with bad credit

Here are the steps to get a loan even if you have bad credit.

1. Fix your credit

This step is both the easiest and the hardest. If you can fix your personal credit score by paying off certain revolving lines or having offensive false reports removed, do so as soon as possible.

Even if it’s not easy, you still have to work on it. Check your personal credit once a month on your personal bank accounts or on credit card websites. Pay credit cards monthly. Pay all overdue accounts.

If your business’s credit rating is low, you might be tempted to pay the reporting agency to fix it. I would never do that in any of the companies I work for. I think it’s a racketeering. You pay thousands of dollars to have someone at the reporting agency automatically dispute any late payment claims, and then, maybe, your score will go up. This defeats the whole purpose of the score.

There are, of course, other steps you can take. Create a free account with the agency and submit business referrals. You can also manually enter and dispute any false late payment claims. This may or may not increase your score.

If you have a low score, do whatever you can without paying to fix it and prepare a letter for the bank explaining the situation. Most bankers understand that scores are random.

2. Work on financial forecasts

If you have bad credit because your business is losing money, you will need to work on a financial forecast. Show the bank how you are going to turn the business around and what the financial situation will look like in a year or two.

Start with a detailed budget and explain what costs can be cut and how to increase revenue.

3. Have thick skin

If you have bad credit, you need to develop thick skin. Some bankers review hundreds of loan applications a year and have to turn down anything imperfect just to get through the day. You may have to go through a lot of rejection before you figure it out. The key is to persist.

3 options for small business loans with bad credit

Here are three places you should consider applying for business loans with bad credit.

1. Community Bank

When I worked at a community bank, we affectionately called each other “the local lender of last resort.” Community banks generally have a higher cost of funds than national banks, which can spread regulatory and overhead costs among many more borrowers. For this reason, the interest rates that community banks have to charge are higher.

Many community banks focus on building lasting service-based relationships to offset their higher prices. They must also accept borrowers that the big banks might refuse.

Research local banks and consider transferring your entire banking relationship to them if necessary for small business loans, even with poor credit.

2.SBA

Government loans for businesses with bad credit come from the Small Business Administration (SBA). Loans are technically issued by banks (you can use the same community bank mentioned above) and guaranteed by the SBA. The guarantee reduces the bank’s risk and makes it more willing to lend to those with weak credit.

3. Hard Money Loan

The last resort is a hard money loan. Hard money loans come either from high net worth individuals or from non-bank lenders who manage cash reserves. Hard money loans will have shorter terms, higher interest rates and more prohibitive restrictions than anything you would find at a bank.

If you really need it, find a local loan broker that has good reviews and work with them to find the most trustworthy lender.

3 tips for finding a small business loan for bad credit

Here are three tips to keep in mind when looking for business loans with bad credit.

1. Know your business

As an investment banker, the most frustrating times for me were when I had to tell my borrowers about something about their business or their credit that killed the deal. Go to all meetings with bankers knowing as much as possible why your income statement line items have changed, why you have late payments on your credit file, or even why you’ve had overdraft charges recently.

2. Have a plan

Whatever problem has hurt your credit, you need a plan to fix it. It can be helpful to have a meeting with your key personnel and write down exactly what happened and how you are going to fix it.

Simply having a plan to improve is better than 90% of businesses with bad credit.

3. Run

Of course, having a plan is not enough. Banks will start to find you more creditworthy once you can show that you’re actually following the plan and executing it, when you have interim financial periods that show a turnaround, or when you start to pay off your debts.

Good credit, bad credit, no problem

The key is to understand what your options are for reducing your leverage and fixing your credit scores. If you need to refinance a business or personal loan, do it. If you need to get a hard money loan to buy new office space and increase your income, do it.

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