So you’ve established your business, poured your heart and soul into getting your enterprise off the ground, worked out a solid business plan and roadmap for profitability…. but there’s a problem – you need funding. You could be looking for financing in order to grow your business to scale, expand your inventory or equipment, or to keep your head above water in tough financial times.
Applying for a loan for your small business is a natural step that the vast majority of entrepreneurs will take during their business’ lifecycle. But what happens when your application for a loan is denied?
Research that shows the percentage of small business loans that get denied is quite high. Only around 57% of general small business loan applications made to traditional banks are approved, with SBA loans having a 52% approval rate.
In other words, 48% of SBA loan applicants and 43% of applicants to traditional banks will likely see their requests rejected. You are definitely not alone if your small business loan has been turned down.
Read on to learn more about why banks deny loans to small businesses, what you can do to improve your chances of a successful loan application in the future, and ways to move forward after your application was turned down.
Why do banks reject loan applications?
The answer to this question is complicated. Banks and other financial institutions are conservative when it comes to lending, preferring to deny applications from businesses that they think could end up defaulting on their payments.
Current global events, including rising inflation and an impending recession, have also made banks especially wary of lending to small businesses. The reality is that widespread volatility in both domestic and international markets has made taking a chance on lending to a small business unappealing in the eyes of many banks.
However, there are specific factors related to your business that make lending to you either a worthwhile opportunity or a risk too big to take.
What disqualifies you from getting a loan?
There are a number of different elements at play that can lead to a financial institution rejecting your loan request. They all boil down to one concept: risk.
Banks are looking to lend to businesses where the chance of default is as low as possible. They want to provide financing to businesses that will make loan payments on time like clockwork every month, and they prefer financing businesses that have a clear profitability model in place or operate within industries that have low failure rates.
Here’s a summary of the most common loan denial reasons facing small businesses who are looking to borrow from banks and other financial institutions.
A poor business credit score or insufficient business credit history
Your business credit score is one of the most important factors weighed by lenders when reviewing your loan application. This score reflects your business’ overall fiscal responsibility, whether you pay your vendors and suppliers in a timely and consistent manner, and confirms that your business isn’t subject to liens or other major outstanding financial obligations.
Even if you pay your invoices on time, not having sufficient recorded business credit history can pose a problem. If your suppliers or vendors don’t report your payment history to a business credit scoring company, your consistency and reliability – which can help you secure a loan – won’t be documented within your credit history.
It’s important to remember that even if you have an amazing personal credit score, that doesn’t necessarily mean that your business loan application will be approved. It’s also critical to note that different lenders may use different criteria to determine legibility. Business credit and personal credit are two separate entities, which pull information from different sources, and utilize different scoring criteria.
Not enough collateral
Collateral is critical for securing a business loan, and not being able to offer sufficient collateral greatly increases the chances of your application being rejected by the bank. Regardless of your credit score, cash flow, or overall business success, you typically need a sizable amount of high-value collateral, especially for a larger loan.
Because it serves as an insurance policy for the lender in the event that you stop paying back the loan, collateral must be enough to cover the majority – and in an ideal scenario for the bank, the entirety – of the loan. Banks want to be sure that they can recoup the losses if you default. They need assets on hand that they can liquidate or utilize in order to cover the remaining balance of your loan.
If you can’t secure sufficient collateral to secure a business loan, there are a few alternative options you can consider. Some lenders will allow equipment or inventory financing, which lets you put up those business assets as a guarantee in exchange for financing.
Your business operates in a ‘risky industry’
As unfair as it may seem on the surface, there are industries which banks prefer to do business with, and other industries that they tend to avoid. If your business is in an industry which a financial institution perceives as being on shaky ground, especially one with documented high failure rates, your loan may be rejected based on that criteria alone.
Believe it or not, even with sufficient collateral, a solid business plan in place, and an excellent business credit score, a lender may turn down your application due to an in-house blanket ban on granting loans to businesses in your specific industry!
For example, restaurants are often perceived by banks as being high-risk. CNBC reports that a staggering 60% failure rate for new eateries is par for the course in the US. In other words, nearly one out of three independently-operated restaurants fails within its first year of operation. When breaking down the numbers, it’s clear why banks would be wary of lending to these businesses.
Some banks also have policies in place which forbid them from lending to businesses in so-called “vice industries,” such as adult entertainment, gambling, and the like. This could be due to fears about them operating in legal gray areas and potential legislation rendering the business outside of the bounds of the law at the drop of the hat, or a general fear that lending to such businesses could negatively affect the lender’s brand reputation.
My business loan was denied. Now what?
The good news is that a denied loan doesn’t mean you’re out of options when it comes to securing financing for your small business. If you’d still like to receive a business loan from a traditional bank, there are a number of steps you can take to boost the likelihood of receiving a loan in the future.
You can improve your business credit score by paying your vendors and suppliers consistently and punctually, as well as ensuring that you don’t maximize your available credit on any business credit cards each month.
Make sure that your suppliers and vendors report your payments to business credit score providers such as Experian, B&D, and Equifax, so that there’s a documented history of your business’ financial responsibility. Try to pay off any outstanding debt your business has accrued as soon as possible.
Finding ways to increase the amount of collateral you offer in exchange for the loan can also increase your chances of your application being approved.
If you’re interested in pursuing options outside of the traditional business loan route, you can consider equipment financing, inventory financing, and accounts receivable financing. Under these models, you can receive funding in exchange for a guarantee to allow lenders to take possession of your future payments from customers, inventory, or equipment should you default on the loan.
Online and alternative lenders may offer other routes to a business loan that are friendlier to ventures with shaky or minimal business credit history and limited collateral. Some of these lenders will accept a personal guarantee or UCC lien to secure your loan.
Revenue uses different criteria for financing eligibility than traditional financial institutions. To learn more about financing options with Revenue, you can click here.
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