5 Main Reasons Banks Turn Down Small-Business Owners for Loans
You were counting on that small business loan to help your business grow, but the bank said "no." If it makes you feel any better, you’re not alone.
Over the last couple of years, large banks have been reducing the amount of loans that they’re issuing to small businesses. The Wall Street Journal reports that it may be because of, “Weak demand, tighter lending standards and high costs have put a lid on small business borrowing” following the 2008 economic crisis.
However, getting rejected is never fun, even if the circumstances are out of your control. That’s why you should know exactly why your loan was rejected in the first place so that you can make sure that it never happens again.
Sometimes a bank will share these details, but if not, I find that it's typically for one or more of the following five reasons:
1. Bad credit
Credit history is one of the first things that lenders will review when going over a business loan application. A good credit score proves that the business owner has properly managed both of their personal and business finances by avoiding bankruptcy and making all of their payments on-time.
A poor credit score, however, can make lenders wary since it demonstrates that the individual can not make well-informed financial decisions and are unable to meet the financial obligations that are included in the loan agreement. This is even the number one reason why a payment processor like myself will reject you and your company from even accepting payments.
The good news is that you can repair your low credit score by paying your bills ontime, getting your credit card balances under control (not cancelling your cards) and repairing any mistakes that appear on credit reports. Keep in mind, bad credit on either the business owner or the business can impact the business getting a loan. Here are a few other credit myths I've put together that you should know about.
Related: Busting 5 Myths About Small-Business Lending
2. Weak cash flow.
“Banks are very concerned that businesses have enough cash flow to make monthly loan payments in addition to covering their payroll, inventory, rent and other expenses,” says Warren Lee of TheLendingMag Media Group. “Unfortunately, many startups and small businesses struggle to keep enough money in their bank accounts even when they’re profitable, often because they have to pay 3rd-party suppliers upfront before they get paid for their product or service.”
By creating a sticking to a budget, small business owners will have a better idea on how much cash is coming and going through your business operations. If you notice that there is a weak cash flow then you need to cut expenses and find ways to bring-in some extra so that banks won’t reject your application.
Related: Need a Bank Loan for Your Small Business? Timing Can Make or Break Your Chances
3. Time in business and limited collateral.
For new small business owners, obtaining a bank loan may seem like one of the best ways to jump-start your business, or at least get you through your first trying year. Amy Blatterfein points out in an article for Ventury Capital, “Loans for those situations do exist. But, you are not going to find them at your local bank. If you’re looking for a traditional simple interest business loan with a monthly payment you’re going to need to be in business for at least two years.”
You may even have difficulty qualifying for this type of loan until you’ve been operating for at least three years. The reason? Traditional loans require two full years of tax returns to prove consistent gross and net profits. Additionally, small businesses that are just starting out often don’t have the collateral, such as equipment or real estate, required if your business ever defaults on the loan.
You may have to look for alternative sources of funding, such as peer-to-peer lenders, crowdfunding, or online merchants, if you just started your business. As for collateral, you can use personal assists like your home or vehicle.
Related: 3 Startups Offer New 'Microloan' Options for Entrepreneurs With Big Ambitions
4. Lack of preparation
“Many businesses simply aren’t savvy about the application process and believe they can walk into a bank, fill out an application and get approved for a loan,” says Mark Palmer, managing director and analyst at BTIG.
Prior to applying for a bank loan, the Small Business Administration suggests that you have a written business plan, financial statements or projections, personal and business credit reports, tax returns, and bank statements. Also included should be copies of legal documents, which include articles of incorporation, contracts, leases, or any licenses and permits that you need for your business to operate.
Related: 3 Strategies for Getting Into Lending Shape
5. Outside conditions
What if you have a solid credit score, strong cash flow, collateral and have prepared everything you need for loan, but are still turned down? It could be no fault of your own. It may just be outside conditions that are out of your control.
“Outside influences are always considered prior to a loan approval or decline,” says Diane Roehrig, president of Alacom Finance. “They can include industry experience (do you have the work background to manage your own business), a business’s location, local or regional economic trends, competitors.”
Furthermore, Roehrig says that there are local, state, and federal ordinances, along with factors like, such as local climate conditions, that could influence an applicant’s approval or denial.