5 Common Reasons Small Business Loan Applications Get Refused (& How To Avoid Them)
Being denied a small business loan is practically a rite of passage for entrepreneurs. Rejection rates can reach 73% with traditional banks. The odds improve a bit with alternative lenders, who typically approve around 57% of small business loan applications, but rejection rates can be daunting.
Ready for some great news? Lenders turn down loan applications over and over again for the same often preventable problems. When applying for a loan, it helps to think like a lender. Consider five common reasons why small business loan applications are frequently turned down and take steps to avoid these common pitfalls.
- Not enough time in business
Traditionally, banks require that you have been in business for at least two years, although an exception can be made for an SBA (very competitive) loan, part of which is guaranteed by the government through the Small Business Administration.
While there isn’t much you can do to speed the clock and get more trading history under your belt, you can look beyond traditional banking. Alternative lenders tend to have a less stringent requirement for the time in business; one year is usually sufficient, or even less in some cases.
It’s also worth noting that accuracy is important when reporting time spent in business on your loan application. Experience in a similar industry does not equate to time spent in business and should not be taken as such when applying for a loan. What lenders want to know is how long the business borrowing the money has been or incorporated.
While including the history could be a seemingly innocent mistake, this type of misrepresentation can easily result in your claim being rejected.
- Asking too much or too little
We know what you are thinking: may ask too little capital really hurt your chances of getting financing? In short, yes, depending on who you are applying for the loan from. Traditional banks generally issue larger loans, on which they earn more interest.
Banks may be less likely to approve smaller loans of less than approximately $ 250,000. Why? It’s all about numbers. It takes banks the same time, the same effort and the same resources to honor a seven-figure loan than a five-figure loan, on which they earn much less money.
Alternative lenders, on the other hand, typically lend smaller amounts than commercial banks, and the application process is generally much faster and easier. However, it is essential that you prove that you can repay the amount you are requesting in your application.
If you ask too much, without showing the lender exactly how you plan to repay the loan, your application will be rejected. If your current cash flow is not strong enough to comfortably cover loan payments for the amount you are requesting, you will need to itemize future projections to show exactly how you will get there.
Increase your chances of getting approved for a small business loan by adjusting the amount you request, depending on who you are applying to, and be prepared to prove that you can cover the amount you request.
- Bad credit
Your personal and business credit can affect your chances of getting approved for a loan, as well as your interest rate if you are approved. Lenders often view the credit scores of majority stakeholders as a reflection of the company’s ability to repay the loan. The newer your business (and the shorter your history), the more consideration your personal credit will be, especially if you haven’t yet established business credit.
If you are applying for a loan from a commercial bank, or an SBA loan, your commercial credit will also be considered. Always check your personal and professional credit reports before applying for a loan and correct any potential mistakes that could lower your score. If either credit score is low (less than 600 for personal credit), it’s a good idea to take steps to improve it before applying for a loan.
If you are worried about your credit for any reason, consider applying for a loan from another lender. These lenders are generally more forgiving when it comes to credit scores and pay more attention to cash flow as an indicator of your creditworthiness.
If your credit is low, you may also want to consider financing bills or borrowing against your unpaid bills. With invoice financing, your beneficiary’s credit outweighs yours.
- Low cash flow
When it comes to qualifying for a small business loan, cash flow is king. Lenders want to make sure that your business has enough positive cash flow to cover your operating costs, as well as your loan repayments. Traditional lenders will consider at least one to two years of your cash flow history, while alternative lenders can look at as little as three months of your banking transactions.
Lenders also look at your ability to maintain a positive bank balance, and ideally a balance that grows steadily. If more money comes out than it comes in, or the margin is too tight, your small business loan application may not be approved.
Need help improving your cash flow? In some businesses, getting paid faster is essential. No matter what industry you are in, a little planning and analysis can go a long way. Using technology-driven processes and tools can also help you visualize, plan, and manage your cash flow, and even detail future projections that prove to lenders that you can repay the loan amount you request.
- Lack of planning
When applying for a small business loan, it’s important to have a strong case for your business that eliminates any doubts a lender may have about your ability to repay the loan. Always define how you plan to use the capital to grow your business, and include a compelling business plan that explains exactly how you will repay the loan. You won’t give lenders much confidence without making a plan for the funds you are requesting.
Being aware of these common reasons why small business loan applications are refused, and taking steps to avoid them will help improve your chances of getting approved.
This article originally appeared on the author’s corporate finance blog and has been reprinted with his permission.