As a business owner or entrepreneur, there’s a good chance you’ll be looking for funding at some point in the life of your business. For some, this is a natural step for launching or growing. For others, especially those struggling with bad personal credit, it can be a step you dread taking.
Here’s the good news, just because you have bad credit doesn’t mean you can’t get financing. It’s not easy, and will likely be an uphill battle, but it is possible. And thankfully more and more alternative lending options continue to emerge for entrepreneurs in this exact situation.
But like anything involving your business, the best thing you can do before applying for a loan or any sort of funding is research and plan. The more you know about how your credit impacts your chances and what options are available to you the better off you’ll be.
Why your credit score matters
Lenders, use your credit score as a metric for measuring risk. The lower your score is, the riskier you and your business appear.
Traditional lenders (banks and credit unions) generally look for a minimum credit score of 650, with many requiring a higher score, before approving your application. This isn’t a hard and fast rule, but it at least provides a benchmark excluding all other factors.
For businesses that have been operating for less than a year, your personal credit score will be the only thing considered. And for better or worse, your personal credit score is typically tied to your business, even after you’ve established a business credit profile. This means both credit scores will be considered in a loan application if you’ve been in business for more than a year, with specific lenders weighing one profile more heavily than another.
How to improve your credit score for future loans
While you can still get a loan with bad credit (and we’ll cover how to do so in a moment), it never hurts to start planning for the future. If you want to get a loan with better terms or think you’ll apply for more funding in the near future, you need to display that you’re a responsible borrower.
Luckily, acquiring and paying off a loan or alternative funding, even if it’s not the best option available, will play into improving your credit. But to really improve your chances, you may want to implement the following ideas.
1. Make payments early or on time
Lenders are interested in how reliably you pay your bills and use it as a predictor of how likely you are to make future payments. Avoid making late payments whenever possible and bring any outstanding balances up to current as soon as possible. You won’t be able to eliminate late payments from your record immediately, but the more you can showcase responsible repayment the less impact it will have on your score.
If you’ve only recently been able to maintain regular payments, but are in good standing with your creditors and vendors, you may consider requesting their support. It can be as simple as a letter vouching for you and your business, that showcases their trust in your ability to pay.
2. Maintain a low outstanding balance
Keeping your outstanding loan and credit balances low is a good way to avoid being labeled with bad credit. Obviously, when you take out a large loan this won’t be possible, but it is a good strategy to pay-off or minimize any other debts before you take out another. There’s no magic number to keep your balances at, but instead, a ratio that lenders will look at.
Your credit utilization ratio is the amount of credit you utilize compared to the amount available to you at a given time. You can find your utilization ratio by adding up all of your debt and dividing it by your total available credit. Typically you want to sit somewhere below 30% to improve your credit score, with the lower the usage the more benefit your score receives.
3. Avoid opening multiple lines of credit
One of the easiest ways to improve your credit is minimizing the number of new credit lines or loans you take out within a short period of time. Applying for credit requires a hard inquiry on your credit report. This can be detrimental if it happens too often and will stay on your history for up to 2-years.
Additionally, having unnecessary lines of credit available may also lead to excessive spending which can make on-time payments difficult to maintain. So only apply for new lines of credit or loans when it is needed.
4. Separate business and personal expenses
As mentioned before, your personal and business credit history will be looked into when applying for a business loan. But as your business becomes more established, your business credit history will carry more weight. If you have bad personal credit, it will benefit you to separate and establish a clean credit history under your company name.
You don’t even necessarily need to start with a business loan. Instead, open a business credit card and apply regular purchases, such as office supplies and utility payments to it. After a year, as long as you keep up with your payments and maintain a low balance, you’ll be in great shape to leverage your business credit history.
5. Build your team
Lenders will typically look at the combined credit history and collateral for everyone with a financial stake in a business. If you can, look to add credible business partners to your team with a clean track record. This will not only improve your creditworthiness but potentially provides you with mentors and additional leadership to help manage your business.
How to get a business loan with bad credit
“Bad credit” refers to a FICO credit score between 300 – 629, but even if you fall within this range, that doesn’t mean you’re ineligible for a loan. As you take steps to improve your credit, you can still look into funding that may be available to you right now. Follow these steps to improve your chances of getting approved:
1. Understand your credit position
You’ve likely already done this as you take steps to improve your score, but it’s always beneficial to know exactly where you stand. You’re allowed one free credit report per year, get yours, look into both your personal and business credit score if applicable.
If you’ve already requested your annual report, there are supplementary scores that can give you an idea of what your current standing is. Just be sure to avoid any options that require payment information or state that it will run a hard credit inquiry.
2. Provide collateral
To help mitigate risk for the lender, you can offer up collateral against your loan. Common forms of collateral include:
- Unpaid customer invoices
- Equipment financing
- Personal assets
- Cash or savings accounts
- Investment accounts
However, this does somewhat increase risk on your end, especially if your business takes a downward turn for a prolonged period of time. So only offer up collateral you’re comfortable losing if things go bad and you need to pay off debts.
3. Add a co-signer
Similar to adding on stable partners, adding a co-signer means they are willing to take on partial responsibility for the loan. Typically you want a co-signer to have good credit and the ability to cover payments if you’re unable to keep up with them.
4. Review eligibility requirements
Every type of financing has its own set of eligibility requirements you’ll need to meet. While a traditional lender will focus on long-term business history and personal credit, alternative lenders will likely require more accessible criteria to determine your creditworthiness.
Do your research and find a lender that fits your needs. Look for options that cater to the strengths of your business to improve your chances of being approved.
5. Apply for a lower amount of funding
Asking for the right amount of funding, that’s supported by your business plan and current financials, will increase your chances of getting a loan. It’ll also make it easier for you to repay. You don’t want to saddle yourself with more debt than necessary, and you certainly don’t want to wind up with a large debt you can’t afford to repay.
Before applying, revisit your business plan, P&L statement, balance sheet, and financial forecasts. Determine if there are any areas you can minimize overhead, cut variable costs, or bring in additional revenue. Run multiple forecasts for best, worst, and actual scenarios to determine how much of a loan you need and can afford if things turn south.
Then apply for that realistic amount. If things go well and you need more to grow, you’re in a better position to pay off your current loan and apply for more financing.
What types of business loans are available for bad credit?
For those with bad credit, the door to getting funded isn’t completely closed. But every financing option is different, and it will take some research on your end to find the best fit for you. Here are the most common lending options you’ll come across to get you started.
Traditional bank loans
This option is less likely to work out for those with bad credit because traditional lenders have limits on who they will finance. That said, it isn’t impossible. Your interest rate will however be higher than a standard rate and more collateral will probably be required of you than a traditional recipient.
If you think you may still qualify, take a look at some of the loan options offered by the SBA.
A microloan is similar to a traditional bank loan, but they often come from alternative lenders like credit unions.
A microloan tends to be easier to get for those with subpar credit because the loan amounts, as the name indicates, are small, typically fifty thousand dollars or less. Because of this, the credit requirements for these loans are also lower.
If this amount of funding suits your needs, this is a great option. The SBA has a microloan program, and there are several alternative lending options available such as Kiva and Accion.
The number of digital and financial technology lenders seems to grow every single day. And for those with bad credit, this is absolutely a good thing. These lenders typically require very different requirements to apply and look at your business track-record and financials more than your credit.
Before applying, you’ll want to check out a lenders track record, services, application requirements, and customer support to see what you’re getting into. You may need to stay within their ecosystem to get financing with better loan terms and higher funding options in the future.
Merchant cash advance
Also known as a business cash advance, this option is only applicable to those having cash flow problems who would need ten thousand dollars or less. Cash advances usually have very high-interest rates meaning that you will almost certainly pay more in the long run than the initial loan, especially if you miss a payment. Be certain you can repay on time before going this route.
Business credit card
If you can secure a credit card in your company name and make purchases and on-time payments, you can get financing and start building good business credit at the same time. Of course, the credit limit, interest rate, and terms of payment will vary, and each bank or credit union will have eligibility requirements, so this option will not work for everyone.
Home equity line of credit
Otherwise known as “betting the farm,” it goes without saying that this is an extremely high-risk option, and only applies to those who own houses. You put up your house as collateral to secure a bank loan.
This type of loan has a niche pool of recipients: you must have a credit score of over 550, your company must make more than a hundred thousand a year in sales, and the loan amount can not exceed ten percent of your revenue. You can receive this type of loan in as little as a week. If you fit these criteria, you can learn more here.
Friends and family
If you do have people in your life who could invest in your business, getting a loan from friends and family is sometimes an option. Of course, for many entrepreneurs who are just starting out and in need of cash, this just isn’t a possibility.
Either the amount they need is too high, or their circle of friends and family is small or possibly strapped for money themselves. Your friends and family may think it’s too risky because of your bad credit as well.
What to consider before applying for a business loan
Why each type of lender varies in regards to requirements, benefits, and drawbacks there are some core elements to consider before applying to any of them.
Different lenders require more or less financial and planning documents to be considered. The best thing you can do is keep your planning and financial documents up to date, and find lenders that fit how long you’ve been in business. If they ask for more documentation beyond the years you’ve been in business, find alternatives to support your case instead.
Annual percentage rate (APR)
This is simply the annual interest rate you’ll be paying on your loan. Typically a lower credit score or alternative lending option means you’ll have a higher APR. Make sure you can manage the interest before taking a loan and always look for options that provide the opportunity for lower interest rates over time.
How long do you have to repay the loan? Are there long and short-term options with different APRs and fees? Make sure you know how long you have and what the possible options are to decrease additional costs.
There isn’t always going to be a required down payment depending on your lender. And they’ll often accept some form of collateral if one is necessary. In some cases, you may want to look for options that provide better terms (interest rate and time to repay) in exchange for an initial payment.
Additional costs and fees
There will always be some additional or underlying fees to be aware of. Processing, underwriting, and late payment fees as well as closing costs can tack on additional expenses you may not be prepared for. Ask about these up front and be sure you can cover them or have them waived by the lender.
Improve your chances by being prepared
No matter your credit score, business history, or current financial state, the best thing you can do to improve your chances of being approved for funding is to prepare ahead of time. Do your research, vet your lending options, and review your business plan and financials to ensure a loan makes sense for you right now. Doing so will ensure that you can approach any lender with confidence and the documentation necessary to be approved.
If you need to create or update your business plan, you can get started with our free business plan template. And if you’re looking for a simpler option that can also help you develop an investor-ready pitch deck, you may want to check out LivePlan. With LivePlan, your plan is more than a stack of paper for lenders to look at, it becomes a tool for growth. With automatic financials and step-by-step guidance you can spend less time building your plan and more time running your business.
Now no matter the business planning option you choose, just getting your plan in order for investors is a vital step to acquire funding. Make everything clear, easy to digest, and focus on the strengths of your business to improve your chances of being approved, even with bad credit.