Most companies are looking to grow and expand. But the process of taking out a business loan isn’t an easy journey down a well-paved road.
More than one-third of all small businesses who apply for a loan are rejected. And most don’t understand why. Here are five reasons why your business might be rejected for a loan and what your company can do to increase your approval chances.
1. Not Supplying the Correct Documentation
Let’s face it; paperwork can be overwhelming and confusing. However, it shouldn’t be the reason a business gets denied a loan. Sadly, it is one of the most common causes of rejection.
Not submitting the correct documentation for a credit renewal will increase a company’s chance of getting rejected. Here are the types of documentation you should expect to present:
- Annual financial statements
- Tax returns and previous year data
- Personal financial statement from the guarantor (who is typically the owner)
- Financial projections for the next 1-2 years, especially when an increase is needed
- Loan contracts per the loan agreement. This shows the financial health of the business and eliminates loan defaults or lump-sum repayments occurring at the last minute, which can cause financial stress.
If your business plans to ask for a loan, having these documents prepared can increase the chance of being approved and ensure your line of credit is revolving per plan.
2. Lack of Cash Flow
Cash flow is the very first aspect that a lender looks into when considering granting a company a loan. Banks want to see that a business has enough money to make the loan payments as well as other expenses like rent and payroll. If a company has irregular cash flow or if they experience seasonal variations, these could be a red flag for a lender.
A lack of cash flow is one of the primary sources of business failure. If a lender rejects you for a loan and states cash flow being the reason, it should be a signal to take a hard look at how cash flow is being managed. Implementing accounting software is a good place to start. If that seems overwhelming or if you don’t have the manpower, then hiring an accounting firm could be a helpful alternative to get back on track. Also, be diligent about collecting payments due from customers—don’t let invoices drag out to 60, 90, or 120 days past due. The more proactive you can be, the better off your business will be.
3. Poor Credit or Lack of Credit
The National Small Business Association published a Year-End Economic report for 2017. The report stated that for businesses for which capital availability was an issue, 31% reported they’d been unable to obtain the funding they needed.
Business credit is important for small companies as it enables them to obtain the capital needed to grow. This additional capital might be used to purchase additional inventory, hire employees, and cover other necessary expenses.
For example, a company with a FICO score under 640 is likely to be rejected for a loan. If that company needs a loan, there are a few things they can do to improve their credit score. They can start by paying bills on time, opening multiple credit cards, keep revolving debt low, and regularly monitoring their credit report.
4. Haven’t Been in Business Long Enough
The rate of small business failure may be shocking to learn. Here are some quick facts:
- 20% of businesses will fail in their first year
- 30% of businesses will fail in their second year
- 50% of businesses will fail in their fifth year
- 70% of businesses will fail in their tenth year
There are many reasons why a business might fail, which is precisely why banks want to see a track record from a company — to prove that they can pay back a loan.
Lenders want to see that a business has experience in the market and brings in substantial revenues. Of course, it’s possible to have a successful and thriving business without having been operating for very long. In this somewhat unique situation, it would be a matter of finding the right lender. If a business owner fell into the more common category of not being incredibly successful from the start, they can use personal assets as collateral to secure cash and have a better chance for approval.
5. Lack of Collateral
Small and midsize businesses can be seen as a risk to many lenders. While not all small business loans will need collateral, it would 100% be required if a business is directly borrowing against an asset. Without secure assets such as equipment, inventory, or property as collateral, your business loan could be denied.
Similar to a business just entering the market, leveraging personal collateral can demonstrate that your dedication to the business while also reassuring the lender. Putting up personal assets, like a house or car, as collateral can lower the interest rate on the loan. If personal assets are not an option on the table, you may need to look into alternative sources of financing.
The process of taking out a business loan can be tedious and complicated for many small and midsize business owners. While these are only some of the possible situations your company might face when seeking a loan, you can always contact Signature Analytics for help. We can assist in securing new lending or ensuring your line of credit is revolving per plan, so contact us today.