How can I get a small business loan with less than two years in business?

Most lenders want at least two years of business history. They want to feel confident that you will still be here when the loan is repaid. A new business just doesn’t have the historical track record, and about 20% of all new businesses fail within the first year and nearly 30% fail by year two.

Two years in business allows a company to show a lender a few things:

• cash flow and financial discipline over time
• ability to handle credit and debt responsibly
• ability to get the business profitable
• current and future viability of the business
• a more reliable business credit score and debt service coverage ratio

Two years also gives a business a chance to build up its assets so the business can make a pledge as collateral. There is no hard rule, though, and every lender can decide for itself what it is willing to do.

That said, two years is still the norm whatever you look at, whether it’s alternative and online lenders, credit unions, and/or traditional banks.

If a lender turns you down for being too new a business, your goal is to show creditworthiness beyond your years in operation. The younger you are, the more important owned assets and financial data becomes to offset the short history. Below, we’ll hit each of these points in detail, along with a couple alternatives if financing doesn’t work out.

Your track record and what you own

Two years in business means you have already filed at least two years’ worth of tax returns. That’s at least two years of financial responsibility a creditor can reference to get a sense of how you manage money and debt. It also means at least 24 months worth of cash flow data on how much money comes into your business, how quickly receivables are paid, and revenue patterns.

For a lender, it means they have hard data on how much cash will be available for a loan payment every payment period. A stable business is likely to start acquiring assets of its own too.

Now, obviously, assets only count once you actually own them outright and in full. That could mean store fixtures or manufacturing equipment or computers or office furniture. When you have collateral to secure a loan it reduces the risk for the lender and improves your approval chances. A brand-new business probably just doesn’t have enough paid off assets.

Profit and planning ahead

Two years of data on hand gives a business many chances to spot inefficiencies, trends, growth opportunities, and make projections aligned to real market opportunities.

If a new business wants financing it needs to have a plan to show growth opportunities and how the money will be spent. Say demand for your service or product is so strong you can’t deliver enough in a day, and you’re sure that given the chance, you can expand output and gain more customers. The data proves that an increase in resources will pay dividends if a working capital loan is approved. Data is king when planning to ask anyone for money.

So if that business can show that a working capital loan would support hiring a manager and employees to produce more per day to meet demand, and stay on top of new orders, it’s a great case to make. Same goes for buying inventory or raw materials. Forecast that impact and your ability to repay it, and the case is made.

Data is not just for loans, it’s also valuable information about customers and market. Businesses that have good intel can plan for expansion or cutbacks to improve performance. A hair accessory shop learns that the bulk of its buyers are mothers through a year of keeping data. It adds kids hair ties to its shop. A restaurant learns the audience and can tailor its food and ads for the type of diners it wants. Knowing your audience helps support new products or locations, and creates new ads aimed at similar diners in an area.

That’s exactly what a lender is looking for. Someone who’s brand new on the scene gives a much less clear picture and a lot harder time to predict anything.

Business credit scores and debt coverage

New businesses don’t have the same built-in past experience either. It takes time to start building a business credit profile. Things like total business debts, payment histories, and credit available are also tracked. Paying on time and as agreed with lenders and with rising credit limits helps the score grow.

The older the business credit history, the easier it will be for a lender to decide which borrowers are good and which are bad. And sometimes it turns out a business looked risky in the beginning, but is actually one of the most reliable borrowers a lender could wish for. For example, a business that carried an equipment loan early on in its life but paid it on time. Here’s roughly what a solid profile looks like, assuming two years and 3 to 5 reported tradelines:

• Dun & Bradstreet PAYDEX: 0 to 100, and 80 or higher is good.
• Experian Intelliscore: 0 to 100, and 76 or higher is good.
• Equifax Business Credit: 0 to 100, and above 80 is good.
• FICO SBSS: 0 to 300, and SBA loans and banks look for about 160-200.

To build business credit start with the basics, like credit cards, rent and monthly bills all paid on time. Ask suppliers for net 30 terms and reporting to the credit reporting agencies; if you have a long relationship with them they may be happy to help. Next up is to improve your debt service coverage ratio.

The debt service coverage ratio is a lender’s check to see how able you are to pay back a loan with interest. Basically it’s net operating income divided by total debt service (the loan payment plus any interest charges). A 1.0 value is the break-even point; anything over a 1.0 gives you a surplus of cash on hand and a better chance of repayment. Anything under a 1.0 is a riskier borrower category.

If your DSCR and credit scores aren’t great, don’t worry too much. It’s not a deal breaker. There are other steps you can take to make up for a short time in business.

How to improve your odds

There are several ways a new company can improve its chances of getting approved:

• Ask your vendors to report your on-time net 30/60/90 payments to the credit reporting bureaus.
• Open a checking account or credit line with the lender you want. It shows commitment and can create instant business history.
• Add collateral, if available, or provide a larger money down amount.
• In some instances where you’re already offering a personal guarantee on the loan, you may be able to offer a higher dollar cap, or an uncapped guarantee.

If you didn’t find a loan, you can always turn to other financing options. Friends, family, investors, or even equity financing could be an option. A business credit card or line of credit could also build a history to show the same thing as a traditional loan. A high on-time payment record can be reported to the credit bureaus, further improving approval odds in the future. Just know that cards and credit lines usually give you less money than a loan.

In the end, the two-year rule isn’t set in stone. If you have plenty of cash flowing through your business (or enough assets), some lenders may take you, even if your business is very, very young.