How to Get a Small Business Loan With Bad Credit

Our local convenience store recently closed for a few weeks for renovation. When it opened again, I was pleasantly surprised to find self-checkouts available. The time it takes me to go get a Diet Mountain Dew has gone down by at least half. My dentist couldn’t be happier.

Businesses are doing whatever they can to automate processes and banks are no different. Many banks are underwriting all loans under a certain amount (sometimes the amount is as high as $1 million) with algorithms -- even the 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 learn about 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) decline the loan or push for an explanation. Business credit is harder.

Having poor business credit could mean anything from a bad debt service coverage ratio to a bad business credit score.

For any business loan, you’ll 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 financials, competitive position, management experience, and analyze your collateral. If there are problems with any of these items, you’ll need to understand how to cure them.

Many banks will pull a business credit report as part of the underwriting process. Business credit reports are largely derided by business owners. The business I work for clears over $1 million in net income annually and always pays accounts payable quickly. Still, we have a terrible business credit score.

We are a general contractor and have a pay-when-paid policy that is communicated to all our subcontractors. We do all government work, which sometimes means we are paid six months after the work is done -- that’s when our subs are paid too. It only took two subs with large contracts to report that we paid late to screw up our score forever.

If your bank pulls a business credit report, make sure you know what’s on it and have a response for any negative information.

How to secure a small business loan with bad credit

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

1. Fix your credit

This step is simultaneously the easiest and the hardest. If you can fix your personal credit score by paying down some revolving lines or getting false derogatory reports removed, do it as soon as possible.

Even if this isn’t easy, you still need to work on it. Check your personal credit once a month on your personal bank accounts or credit card websites. Pay credit cards off monthly. Pay all accounts that show as late.

If your business credit score is low, you may be tempted to pay the reporting agency to fix it. I won’t ever do that in any of the businesses where I work. I think it’s a racket. You pay thousands of dollars to have someone at the reporting agency automatically dispute any late-pay claims and then, maybe, your score will go up. It defeats the entire purpose of the score.

There are, of course, other steps you can take. Set up a free account with the agency and submit trade references. You can also go in and manually dispute any false claims of late payment. This may or may not increase your score.

If you have a low score, do everything you can without paying to fix it and have a letter ready for the bank explaining the situation. Most bankers understand that the scores are hit-or-miss.

2. Work on projected financials

If you have bad credit because your business is losing money, you’ll need to work on projected financials. Show the bank how you’ll turn the business around and what you think the financial picture will look like in a year or two years.

Start with an in-depth budget and explain what costs can be removed and how more revenue can be raised.

3. Have thick skin

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

3 options for bad-credit small business loans

Here are three places you should consider asking for bad-credit business loans.

1. Community bank

When I worked at a community bank, we lovingly referred to ourselves as “the local lender of last resort.” Community banks typically have a higher cost of funds than national banks, which can divide regulatory and overhead costs among far more borrowers. Because of this, the interest rates that community banks must charge are higher.

Many community banks focus on creating lasting relationships based on service to make up for their higher prices. They also have to accept borrowers that bigger banks may decline.

Seek out locally owned banks and consider moving your entire banking relationship to them if necessary to secure small business loans, even with poor credit.

2. SBA

Government loans for businesses with bad credit come from the Small Business Administration (SBA). The loans are technically originated by banks (you could use the same community bank discussed above) and guaranteed by the SBA. The guaranty reduces the bank’s risk and makes them more willing to make loans to those with poor credit.

3. Hard money loan

The last resort is a hard money loan. Hard money loans come either from wealthy individuals or non-bank lenders that manage pools of money. 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 one, seek out a local loan broker who 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 searching for business loans with bad credit.

1. Know your business

As a business banker, the most frustrating moments for me were when I had to inform my borrowers something about their business or credit that killed the deal. Go into all meetings with bankers knowing as much as you can about why line items on your income statement have changed, why you have late pays showing on your credit report, or even why you’ve had overdraft charges recently.

2. Have a plan

Whatever went wrong to hurt your credit, you need a plan to fix it. It may help to have a meeting with your key personnel and write down exactly what went wrong and how you’re going to fix it.

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

3. Execute

Of course, having a plan isn’t enough. Banks will start to find you more creditworthy once you can show you are actually following the plan and executing, when you have interim financial periods that show a turnaround, or when you start paying down debt.

Good credit, bad credit, no problem

The key is understanding what your options are to reduce your leverage and fix your credit scores. If you need to do a refinance of business or personal credit, do that. If you need to get a hard money loan to buy a new office space and increase revenue, do that.