Why do most banks require at least two years in business?

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What paperwork does a bank need?

Bank underwriting runs on paperwork. The credit policy asks for two to three years of tax returns, interim financial statements, a debt service coverage ratio, a personal financial statement, and a business credit report with real history. That’s what the loan committee reviews. A business under two years old just doesn’t have most of it yet.

If you filed your first tax return four months ago, there’s nothing for that process to evaluate. And under the paperwork problem sits a bigger one: risk.

How risky are the first two years?

New business failure is front-loaded. About one in five new employer businesses doesn’t survive its first year, and about 30% are gone by the end of year two. Then the curve flattens. A business that makes it to its second birthday is much more likely to make it to its fifth.

By year two, the steepest part of the risk is behind the borrower. That’s why banks drew the line there.

Why can’t a bank just charge startups more?

Because the math doesn’t work. Banks lend depositors’ money on a thin spread. Say a bank books a $100,000 equipment loan, funds it at 4%, and lends at 7%. That’s about $3,000 a year before costs, or maybe $1,500 to $2,000 of real profit.

Now say one loan defaults and the bank recovers 40%. That single loss is about $60,000, which wipes out the profit on thirty to forty good loans. To cover that, the bank would need a rate well outside the range banks work in. So instead, banks turn away whole groups of borrowers, and the two-year rule is one of those lines.

Equipment finance companies work differently. They price across a wider range, they know how to resell the collateral, and they look at the operator and the equipment along with the statements.

A file a bank won’t touch is often fundable somewhere else, at a higher rate.

What changes at two years?

• Two filed tax returns. One return shows a number. Two show a direction.
• A real debt service coverage ratio, built on results instead of projections.
• A seasoned business credit file. Dun & Bradstreet, Experian Business, Equifax Business, and PayNet need reported trade lines to produce a score.
• Twenty-four months of bank statements, enough to see a full seasonal cycle twice.
• Comparable borrowing history. A company that has made 24 on-time payments of $4,000 is a different file than one asking to make its first.

How is time in business measured?

Usually from the formation date on your Secretary of State record, not from your first sale. Lenders check that date, so there’s no point describing it differently. A few situations get judged on their facts:

• Sole proprietor who later incorporated. Many programs count the earlier history if you can show prior-year Schedule C filings and continuous bank statements. Ask first.
• Buying an existing business. A stock purchase where the entity survives often carries the history forward. An asset purchase into a new entity usually starts the count over.
• A second business owned by the same operator. Still a startup, but a profitable affiliate can serve as a corporate co-guarantor.
• Buying an aged shelf corporation. Don’t. An old entity with no operating record reads as manufactured history, which is a fraud flag.

What should you do if you’re under two years?

Applying to banks anyway is the worst move. It burns weeks, gets you declines, and adds credit inquiries from multiple lenders that make the next application harder. Here’s what works instead:

• Wait, if you’re close. At twenty months, one quarter changes which programs will look at you.
• Go where two years isn’t the rule. Equipment finance companies underwrite the asset and the operator. That is your market.
• Add a corporate co-guarantor or lead with your industry experience.
• Put more down, or start smaller and build twelve months of clean payment history.

We go deeper in our posts on startup equipment financing and the credit score you need.

What should you do next?

The two-year rule says more about a bank’s process than about your business. The process needs inputs you haven’t produced yet. That leaves two moves: wait until you can give a bank what it needs, or take the file to a program built to underwrite what you actually have.

Five West works both sides of that line. Before you apply anywhere, it’s worth figuring out which side you’re on.

Frequently asked questions

Why do banks require two years in business?

Because two years is when a business first produces what bank underwriting needs: two tax returns, twenty-four months of statements, a seasoned business credit file, and a coverage ratio based on real results. It’s also when failure risk drops sharply.

Can you get equipment financing with less than two years in business?

Yes. Equipment finance companies regularly work with businesses between one and two years old, and there are startup programs for businesses under a year old or with no history. The trade-off is a higher rate, usually 10 to 20 percent down, and more weight on the owner’s credit and experience.

How is time in business measured?

Generally from the formation date on the Secretary of State record, which is verified. Some programs count earlier sole-proprietor history if it is documented with Schedule C filings and continuous bank statements.

Does buying an existing business satisfy the two-year requirement?

It depends on the structure. A stock purchase where the original entity survives often carries the history forward. An asset purchase into a new entity usually starts the count over.

Why do banks charge lower rates but approve fewer businesses?

Because a bank lends depositors’ money at a thin spread, and one charge-off can wipe out the profit on thirty good loans. It can’t raise rates enough to cover that risk, so it manages it by turning certain files away.

Keep reading

More on financing this equipment and how underwriting reads the file.

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This article is general information about commercial financing and is not a commitment to finance. Survival-rate figures are drawn from published U.S. business dynamics data and are national averages, not predictions about any individual business. All financing is subject to credit approval and underwriting.