If, like many entrepreneurs and startup business owners, you’re looking to qualify for a small business loan in Canada at the best rates and conditions, here are the key factors to keep in mind:
1. Business Age
Most lenders want to see that your business has been operating for a certain amount of time. For traditional banks, this can mean you need at least 2 years of business history. Some alternative lenders are more flexible, requiring only 6 months to 1 year in business. However, these will likely give you higher interest rates.
2. Revenue
Lenders typically want to see steady revenue. They might ask for your monthly or annual income to ensure you can handle the loan payments. Some lenders require at least $10,000 in monthly revenue or $100,000 annually to qualify. Others, like Merchant Growth, Journey Capital or Driven.ca can work with lower revenue numbers ($5,000 or so) for certain industries. It’s best to contact them individually to compare their rates and terms for your business.
3. Credit Score
Your credit score matters, but how much depends on the lender. Banks usually want a good credit score (around 650 or higher). Some alternative lenders are more lenient and will approve loans with lower scores.
Some alternative lenders can go down as low as 550, such as Journey Capital, which we called to ask about their minimums). Lenders who accept lower credit scores tend to focus more on your business performance rather than just your personal credit.
4. Debt-Service Coverage Ratio (DSCR)
This is the ratio that mainstream banks and credit unions often use to measure how well your business can cover its debt payments. It’s calculated by dividing your business’s net operating income (how much your business makes after operating expenses) by its total debt payments (loan payments, interest, etc.).
For example, if your business generates $200,000 in income and has $100,000 in annual debt payments, your DSCR would be 2.0. This means you make twice what you need to cover your debts, which is a good thing for lenders.
What’s a Good Ratio?
Lenders typically prefer a DSCR of 1.25 or higher, meaning your business makes 25% more than what it needs to cover its debts. A ratio of 1.0 means your income exactly covers your debts, which is riskier. Anything below 1.0 suggests your business isn’t making enough to cover its obligations.
Debt-to-Equity Ratio
Another related factor is the debt-to-equity ratio, which shows how much debt your business has relative to its equity (the owner’s stake in the business). Lenders use this to evaluate how leveraged your business is. A high debt-to-equity ratio (like 3:1 or higher) might signal that your business has taken on too much debt and could be risky to lend to.
Why It Matters
These ratios help lenders determine how risky it is to loan you money. If your business’s revenue isn’t enough to comfortably cover its debt payments, the lender might see you as a higher-risk borrower and either deny your loan or offer you higher interest rates.
In Summary:
- Lenders check your debt-service coverage ratio (DSCR) to make sure you have enough income to cover your debts. They typically want to see a DSCR of 1.25 or higher.
- They also may consider your debt-to-equity ratio to see how leveraged your business is.
- A solid DSCR shows the lender that you’re generating enough income to comfortably make your loan payments.
So, when applying for a business loan, make sure your business’s income is well above its debt payments to increase your chances of approval.
5. Collateral (Sometimes)
Traditional banks may ask for collateral to qualify for financing, like company’s equipment or property, to secure the loan. However, many alternative lenders in Canada offer unsecured loans, which means no collateral is needed. Shop around!
6. Business Plan
More common request by traditional banks and credit unions, although many types of lenders want to understand how you plan to use the loan and ensure you can repay it. You might need to provide a business plan, especially if you’re seeking a larger loan or applying through a traditional bank.
7. Documentation
Traditional banks and credit unions tend to request the most documents, while alternative lenders generally ask for minimal paperwork. Some will even just ask for financial statements for the past 3 to 6 months to see how much cashflow and revenue your company is working with. In any case, while shopping around for the best rates and terms, have all these documents ready to submit:
- Financial statements (profit and loss statements, balance sheets)
- Bank statements
- Tax returns (personal and business)
- Proof of business ownership (business license, articles of incorporation)
7. Personal Guarantee
In some cases, like with the BDC, lenders may ask for a personal guarantee in order to qualify for a loan with them, meaning you’ll be personally responsible for repaying the loan if your business can’t. This tends to give you better rates, but also means your assets are potentially liable for the loan, so be careful and weigh the pros and cons carefully before deciding if you are going to accept a secured loan.
Conclusion – Where to Start?
The first place you want to go to when you need a loan is your local bank or credit union. These financial institutions generally (although not always) will offer you the best rates and terms for your loan.
That said, it’s in your best interest (no pun intended) to shop around and call different lenders to compare.
Also, if you’re a startup or a small business that needs funding, you might be eligible for government-backed loans like the Canada Small Business Financing Program (CSBFP), which offers loans of up to $1 million with more flexible requirements. Some provincial programs are also available in provinces like BC, Alberta, Ontario and others. You want to check with those to see if you qualify.
In short, qualifying for a business loan in Canada depends on your business’s revenue, your personal and business credit, and how long you’ve been in operation. Be sure to have your financials in order and choose a lender that matches your business stage—whether that’s a bank or an alternative lender like BDC, Merchant Growth, or others.
Mark Turner is a retired financial writer that now enjoys blogging about different financial topics, such as commodities, inflation, debt, retirement, alternative investments and Canadian politics.
