In 2013, Jeff Stibel, CEO of Dun & Bradstreet Credibility Corp, had a message for small businesses that had been denied a bank loan. He told them not to blame the bank. Today, not much has changed. Credit Karma states that there are three lesser-known reasons why business loans get rejected. However, let’s look at the big picture. These are seven reasons why small business loan applications get rejected, and how to improve yours if you are denied.
1. Credit Score
Typically, the primary factor most lenders look at is credit score. Not just personal scores of the owner, but also at the business credit score. Like personal credit scores, business credit scores have multiple bureaus that report on them. Equifax and Experian are two of the major bureaus that report for personal and business, while TransUnion is the third major assessment company for personal finances while Dun & Bradstreet do their reporting on business scores. FICO has also become a reputable company for credit scores.
Many business owners either a) didn’t know that their fledgling company had an individual business score or b) if they did know of it, they didn’t understand or know how to interpret it.
2. Poor Preparation
A proper business plan is the foundation to acquiring a loan. This is your opportunity to accurately and clearly state the ins and outs of your company and show how the lender’s money will be spent. Other documentation that should accompany a business plan are personal and business credit reports, financial statements or projections, tax returns, and bank statements. Furthermore, copies of certain legal documents are important: contracts, leases, articles of incorporation, and licenses and permits used for maintaining and operating the company.
3. Reason for Loan
The business plan should accurately portray this need. But if aesthetic upgrades that don’t improve the function or success of the company are all you are after, lenders will decline monetary support. Though certain accessories and improvements can and should be updated in the right situation, upgrading from the iPhone 7 to the iPhone 8 just because you can doesn’t mean it is crucial to operating functions.
Simply put, collateral gives the bank some assurance they will have something if you default on your loans. Many lenders won’t risk a loan without a promise of reimbursement. Types of collateral include business and personal assets such as equipment inside the company that you own, a vehicle, or even a home.
5. Weak Cash Flow
Your lender needs to see you have money coming into your company each month. This amount needs to exceed your rent, utility bills, payroll, inventory, and other expenses that are vital to company operations. Small businesses can often struggle with keeping enough capital in their accounts due to third party vendors requiring upfront payment.
6. Lender Stipulations
These are different with each lender, but they include aspects like the amount of debt you already have, how old your company is, the amount of money you are asking for, etc. Many businesses are denied loans due to the fact they either weren’t aware of these stipulations or couldn’t meet the criteria necessary.
7. Economic Conditions
Sometimes, the situation is out of your control based off the current situation with the type of business you own and the economic factors that surround it. For example, if you offer a food delivery service and the price of gas has gone up 25% in the past month, lenders might view your company as too risky due to the fluctuating costs involved with gasoline prices.
Now that we know something about why you were denied, the question is…
How do we get approved the next time we apply?
Let’s take a look at the seven reasons we were denied and evaluate how to improve them.
It is harder to build credit than to destroy it, but it isn’t impossible. Understanding what your credit score comprises will help determine what you need to fix it. Here are some tips to improve your score.
- Make timely payments.
- Keep your credit-to-debt ratio low. This doesn’t mean that you need to have all your debt paid off, but that if you have a credit limit of $50,000, you don’t have $49,000 of it used up.
- Don’t continue to open new lines of credit. This will stretch your mental and monetary capacities to the limit. It also has an effect on the final point.
- Let your credit lines age. The older your credit is, the better it looks on your credit report. According to Credit Karma, five years or older is the ideal age for credit lines.
A business plan is all in the details. Some qualities that yours needs to demonstrate are:
- Thorough research.
- Targeted customers or potential clients defined.
- Sound mission statement.
- Achievable and realistic target goals. Based off of your company sales and market research, provide goals that your company can attain and lenders will find believable.
- Detailed analysis of estimates in sales and profit projections. Here is where you give very precise values from what you company has already accomplished, combined with projected sales growth you foresee with the bolster from the loan.
Reason for Loan
Sound judgment should play a factor in these. Lenders are going to look at several reasons for your loan, some of which might include:
- Real estate purchase. Expanding and developing store fronts or factories are a good indication that your company is headed in the right direction.
- Long-term software or product development. Operating systems require state-of-the-art technology to outperform the competition.
- Advertising. Putting your product in front of consumers is important. Lenders understand that advertising is a cornerstone to any successful business.
- Essential equipment. Every company needs certain equipment to operate. There are times that these items are costly, but crucial to daily functions.
- Mitigating seasonal sales variance. Quarterly statements might reflect a dip in sales during certain periods throughout the year. As long as you can accurately show the fluctuation, lenders will see opportunity to get a return on their investment.
Perhaps the most difficult aspect to improve quickly, collateral requires you to own something. If you were denied a loan due to lack of collateral, evaluate a list of current items you are paying off that could be used as potential collateral. Focus on paying these off so you can turn them into a getting-cash line for your company.
Weak Cash Flow
There are some tips to help with a weak cash flow.
- Invoice promptly. Having money coming into your company regularly is important. Being vigilant and punctual with invoices to encourage others to pay you in a timely manner.
- Institute late fees. Every successful business uses them, and so should you. Reinforce what you company is entitled to with the use of late fees.
- Build an emergency fund. This will showcase the ability for the company to grow money while acting as a stabilizing force if unexpected expenses arise.
- Cut unnecessary expenses. Do routine evaluations on what you are spending your money on. Eliminate items that aren’t assets and stick to a more fragile approach to spending.
Perhaps the easiest to overcome to a degree, there a couple things to do to best meet lender stipulations.
- Research the company you are applying with. Understand what they are looking for in a desirable applicant, and present your company in that light.
- Improve upon the areas you were denied the first time. Turning weakness into strength showcases a motivation to improve your business and another reason lenders should reconsider your application.
Again another aspect that is outside the owner’s control; however, when you present your proposal to a lender is pivotal. Mitigate outside interference by researching and understanding where the market is for your specific business.
According to a report by the Wall Street Journal, the percent of loans approved by banks had dropped from 58 to 43 between 2009-2015, with more recent studies reporting that number to be as low as 23.1. To avoid joining this percentile, be aware of the reasons banks reject loan applications. Improve your chances at being accepted for a loan by implementing the suggestions outlined above.