Understanding Bad Credit Business Loans

How to qualify for business credit depends on the lender’s specific set of requirements. When you submit a business loan application, these factors will be most important:

Business credit history. While having an established business credit profile isn’t essential for all types of business credit, it certainly can help. Additionally, it can help the business owner keep their personal finances separate from those of the business.

Credit score. Naturally, a business owner’s personal credit report and business credit score are significant factors in determining one’s creditworthiness. Someone with good credit will qualify for many more business financing options than someone with bad credit.

Annual revenue. Business lenders want to see a solid track record of bank statements that show money coming in on a regular basis. That way they can trust you’ll have the money to make payments. Many lenders will require a minimum annual revenue of $100,000 or more in order to qualify for business funding.

Time in business. An established business will have an easier time qualifying for business funding than a brand new business. Typically lenders will want to see at least one year of an established business structure and funds going into a business bank account, but some lenders may qualify business owners with as little as six months of history.

In the absence of these standard eligibility requirements and with bad credit, a business owner might look into secured (collateralized) funding, getting a co-signer, or exploring non-lending sources of funds such as crowdfunding or grants.

If you have a poor personal credit score but need funding for your business, some financing options might include the following:

Equipment financing. If it’s equipment that you need, equipment financing might be a good fit. Because equipment loans are a type of secured funding in which the equipment itself is used as collateral, this type of financing is easier for a business owner with less-than-perfect credit to receive approval. Equipment leasing may be another type of equipment financing option for you as well, depending on the type of equipment you need.

Invoice financing. Invoice financing can leverage your accounts receivable in two different ways. The first way, generally known as just “invoice financing” involves receiving a loan with a set repayment term and interest rate in exchange for unpaid invoices, which are used as collateral to secure the loan. The second type is invoice factoring, in which a factoring company purchases the invoice from the business at a factor rate. That allows the factoring company to purchase the invoice at less than its full value, but they assume responsibility for collecting the money for the unpaid invoice.

Get a co-signer. If you have bad credit but know someone willing to support you by taking responsibility for the loan if you’re unable to repay, using a co-signer would be an option. It’s important that the person co-signing fully understands your business plan and can trust that you’re going to be making good on these payments before signing.

Some business loan products can come with low credit score requirements or may be well suited for business owners with poor credit. You should always check for the minimum credit score before completing an application — even if the type of funding is thought to be a “bad credit loan.” In addition to secured funding options such as equipment financing and invoice financing mentioned above, here are other common business loan options:

SBA loans. SBA loans are loans that are backed by the U.S. Small Business Administration. Because they are guaranteed to be repaid by the government if the business is unable to repay, the loans come with very good rates and terms. While those with a bad credit score may be able to qualify, the business’s credit must be good enough to assure loan repayment.

Business line of credit. A business line of credit is a type of funding in which the borrower receives a set amount of credit (known as their credit limit) from which they can draw and use as cash. As the borrowed money is repaid, the available credit replenishes to be drawn from again. Because of their revolving nature, lines of credit have become some of the most popular working capital loans for small businesses.

Business term loan. Business term loans, also known as small business loans, are traditional loans where an upfront amount of money is given to a borrower and repaid in installments over a specific period of time. When the amount of time for repayment is within a couple of years, these loans may also be called “short-term loans” or “short-term business loans.”

Merchant cash advance. A merchant cash advance (or “MCA”) is a type of funding in which the borrowed funds are typically repaid daily with a percentage of your business’s credit card sales. If the sales aren’t high enough, it may instead be repaid via a monthly withdrawal from your business bank account, depending on the merchant cash advance provider.

A business credit card is oftentimes the first type of business financing used by a startup business. Most business owners feel familiar with that type of funding because of their experience with personal credit cards. Similar to personal credit, it’s always helpful to have a strong FICO score when you submit your application. If you don’t, you may consider applying for a secured business credit card.

With a secured business credit card, you secure the credit line with a down payment that acts as your initial credit limit. As you borrow and repay on time, the credit card issuer may make more credit available to you.

Interest rates for business loans vary, but without a strong credit profile, they will typically fall in the range of 25% to 99%. The majority of non-bank business loans are closer to the low and middle of that range. The higher interest rates in that range generally refer to “effective” interest rates for products like merchant cash advances. A merchant cash advance will most often use a factor rate. When a high factor rate is translated into an interest rate, the effective interest rate may be quite high.

Business loans can be either secured or unsecured. Secured business funding types include equipment loans, inventory financing and invoice financing, which use forms of collateral for the loans. Secured business credit cards, secured term loans and secured lines of credit can be secured with a down payment.

In some cases, a personal guarantee may also be used as a means of holding the borrower personally responsible for repayment. If the funds aren’t repaid, the borrower’s personal assets can be claimed by the lender to cover the debt.

With unsecured loans, no collateral is required. It may be harder to receive approval and the borrower will pay interest at a much higher rate, however.

When considering a personal FICO score for a business loan, applicants may want to be mindful of the following categories and ranges:

Poor (<580): Scores in this range are well below the average score of U.S. consumers and suggest to lenders that the borrower may be a risk.

Fair (580 - 669): These scores are below the average score of U.S. consumers, though some business lenders will approve loans with this score.

Good (670 - 739): Scores in this range are near or slightly above average, and most lenders consider this a good score.

Very Good (740 - 799): These credit scores are above the average of U.S. consumers, and demonstrate to lenders that the borrower is very dependable.

Exceptional (800+): Excellent credit scores are well above the average score of U.S. consumers and clearly demonstrate to lenders that the borrower is an exceptionally low risk.

When selecting a business loan with bad credit, focus on specialized lenders or alternative financing options. Consider these steps:

Assess your credit situation. Check your credit rating with the three business credit bureaus: Dun & Bradstreet, Experian and Equifax.

Explore alternative lenders. Consider online lenders, credit unions or microlenders that may have more flexible criteria than traditional lenders.

Compare rates and terms. Evaluate the interest rates, repayment terms, fees and other conditions offered by different lenders. Choose one that aligns with your financial situation and needs.

Consider collateral or guarantees. Some lenders might require collateral or a personal guarantee to secure the loan. Evaluate the risks associated with these requirements.

Check loan amount and repayment schedule. Ensure the loan amount suits your business needs, and the repayment schedule is feasible based on your cash flow projections.

Submit a strong application. Prepare the documents you’ll need, and consider offering your business plan or other supporting documents that may aid your chances of approval.

Read the fine print. Scrutinize the loan agreement thoroughly to make sure you understand all terms and conditions before committing.

Remember, while a bad credit score might limit options, proactive research and a strategic approach can help secure a suitable business loan to support your enterprise’s needs.