Credit can be hard to come by these days, especially for small business owners. Here are the top five reasons lenders reject small business loan applications.
1. Poor Credit or No Credit
Anyone seeking a business loan now needs to have great credit, both personally and for their business. This can create problems especially for new businesses and young applicants. Startups with no business credit history will have to rely entirely on the personal credit history of the owner — if you’re trying to get a loan, your credit history for the past few years needs to be spotless to show lenders your integrity and the seriousness with which you take your debts.
Unfortunately, this means young entrepreneurs with short credit histories can find it virtually impossible to secure traditional financing from banks, and may have to rely on investment from other funding sources, such as alternative lenders, friends, family, and angel investors.
2. Outstanding Debt
Another major pitfall in securing a loan is having a company that is over-leveraged. If your business already has a lot of outstanding debt, whether from other loans, lines of credit, or accounts payable, lenders are unlikely to extend you further credit. Paying down loans and keeping low balances on lines of credit (under 35% is ideal, but if that’s not possible keep it as low as you can) is an important step you can take to make your application more attractive to lenders.
3. Risky-Looking Default Factors
Lenders look at a number of default factors when considering a loan. The five most important are your cash-to-assets ratio, EBIDTA-to-assets ratio, liabilities-to-assets ratio, debt service coverage ratio, and net-income-to-sales ratio. These can be improved by simple efficiency measures, such as using savings to pay down principle on debts, managing inventory so that money is sitting in a warehouse, managing accounts receivable so you’re paid promptly, and examining overhead expenses to see where costs can be cut.
Other measures can help, but may need to be approached carefully: for instance, cutting operating costs will boost your net-income-to-sales ratio, but could cause problems in the long term for quality. You may want to cut costs in anticipation of a loan application to optimize your appeal to lenders, but have a plan for compensating for those cuts in the future.
4. No Collateral
Collateral has become very important to lenders, even for small loans. Lenders simply aren’t willing to risk default without any promise of compensation.
Analyze all of your assets, both the business’s and your personal assets (your house, your 401(k), etc.), and prepare a collateral document itemizing everything that you have to offer as collateral. For business owners that have reached the end of their asset base and don’t have anything to offer as collateral, securing a government-backed loan through the SBA may be necessary to find a willing lender.
5. Poor Business Planning
No lender is willing to take a risk on a business that hasn’t thought through its approach. Vague, poorly researched, and unspecific business plans are a top cause of rejection. Fortunately, this is a much easier issue to address than a lack of collateral or poor credit history. Do extensive research and thorough projections, and prepare a business plan that sells your business and shows lenders you have a road paved out to success. You want your lender to be as enthusiastic about your business as you are.
Fixing weak spots in these five areas will greatly help your chances of getting your loan application approved. If you’ve been rejected but you’re not sure where you’re falling short, ask — submit a written request to the institution that rejected your application within 60 days of the denial, and they are required to give you, in writing, the specific reasons for the decline within 30 days of the request. Then take those reasons to heart so your next application will meet with better success.
Keep reading for tips to follow when you apply for a small business loan: read more.