One of the biggest stress factors in running a business is undoubtedly finances. The last thing that any small business owner wants to see, is a rejected small business loan.
This can be very discouraging – but getting rejected can be an opportunity to learn. Remember that you are allowed to apply again as soon as you figure out what went wrong the first time around.
Here are some of the most common reasons why small business loans get rejected.
1. Poor Credit Score
Lenders look at both your personal and business credit scores when they evaluate your application. Personal scores range between 300 and 900. The closer your score to 900, the better your chances of being approved. Lenders will use this score to see how creditworthy you are and to check the level of risk posed.
New business owners may have to rely only on their personal score.
Some tips to improve your credit score are:
- Regularly review your business and personal credit reports and check for areas of improvement
- Make sure that none of your payments are past due
- Pay all your debts on time or before the deadline
- Keep your frequency of applications low to prevent new inquiries on your credit score report
2. Short Business History
If your business is new or if it’s the first time you’re applying for financing you won’t yet have sufficient business credit or profitability history to be approved.
Your business should be legally licensed, established, and earning a stable income for a couple of years to qualify for the minimum time-in-business requirements.
Banks and credit unions are stricter than alternative lenders. Banks generally require two years of business history, compared to alternative lenders who may only require at least six months. However, the decreased time-in-business requirement usually means higher interest rates.
3. A high debt-to-income ratio
A ratio of between 10% – 30% is usually best. This refers to the percentage of credit you have used versus the credit available. For example, if your business has a credit limit of $100 000, then you need to keep your credit balance below $30 000.
Lenders need to see that you can manage debt, by making debt and then paying it off on time. Not having debt in this case is just as bad as having bad credit.
Also read: Choosing The Right Small Business Accountant
4. Doing business in a high-risk industry
Some industries are deemed less profitable or too controversial for lenders to approve small business loans. This is especially true when it comes to traditional lenders like banks, credit unions and others, where there are rules in place concerning risky industries.
A good example of an industry with high risk is restaurants. This is because of unstable revenue and high failure rates. Others include agriculture and construction.
In the case of a niche industry, it may be better to apply with alternative lenders. These lenders may, however, require more collateral or charge higher rates.
5. An impractical business plan
Generally, lenders will require a business plan when you apply for a small business loan. In this document you should highlight future goals and financial figures. By showing that you have given thought to and looked at things like revenue, debt, assets, liabilities, budgets, and estimated future costs, your odds for a rejected small business loan will decrease.
6. Applying for too little or too much money
Asking for too large a business loan could mean greater risk for lenders. On the other hand, asking for too little has an impact on lenders’ profit margins.
You’d need to find the right balance between the level of risk and the amount of money that the lenders would make in fees and interest.
If you’ve been rejected for asking too little, but wouldn’t like to ask for more, look at micro-lenders or invoice-based financing options that can provide smaller loans.
7. An incomplete or erroneous application
Something as small as a wrong mailing address, an incomplete section, or misspelled name can mean a rejected small business loan.
Documents that are generally required include the following:
– A business plan
– Three to five years of business and personal tax returns
– Business bank account statements
– Financial statements or projections, including profit and loss statements
– Personal and business credit reports
– Legal documents like business licenses and articles of incorporation
Spend enough time preparing and going over your application before submittal to increase odds of approval.
Also read: The Ins and Outs of a Small Business Loan
8. Poor cash flow
Traditional lenders usually require a minimum amount of monthly or annual revenue. The amount depends on the loan amount, type of financing, and the lender.
If no minimum amount is required, financial documents should prove that there is decent cash flow to cover operating expenses, current, and future loan payments.
It is important to properly monitor cash inflow and outflow and ensure that your business’ revenue is more than its expenses.
9. Lack of collateral
Collateral, such as valuable business assets, is required by many lenders to provide security in the case of an outstanding loan balance. This makes sense then that if the value of the collateral is not enough to cover the value of the small business loan amount, then the odds of getting approved is decreased.
Getting your application for a small business loan rejected can be disheartening and frustrating.
Finding out why, and understanding the reasons behind a rejected small business loan can increase your odds of approval for the next loan.
Also read: 5 Financial Mistakes Your Small Business Might Be Making