If your application for a small business loan has been denied, you are not alone. In fact, only about 10 percent of the small business borrowers who apply at the bank leave with a loan. Although the bank may give you a song and dance about why you were denied, it usually boils down to some very basic things:
- You haven’t been in business long enough: Most banks don’t want to lend to companies that are in the first year or two of business. The success rates of a business that is over two years old are much higher and your banker, by his or her very nature is highly risk averse. They usually won’t take a risk on a very young company. You should also know that they will likely use your company tax returns to determine how long you’ve been in business. With that in mind, even if you don’t have much to report, file your returns starting with the first year to establish your company’s age right from the start.
- Your personal credit is bad: Even if you’re trying to establish credit as a business, especially in the beginning, your personal credit and your business credit are pretty much joined at the hip. In fact, unless you have stellar business credit, you’re likely going to have to agree to a personal guarantee. In other words, you will need to cover the debt personally if your business fails to honor the debt. I recently heard from a small business borrower who defaulted on a very large business loan. The commercial property used as collateral had devalued over the last couple of years to the point where seizing it would only repay 50-60 percent of the loan balance. His attorney told him he should prepare for the worst—the bank will likely take everything he owns to repay the debt. On the other hand, if you have incredible personal credit, that sometimes frees up cash for a young business. Like it or not, maintaining your personal credit is just as important to a Main Street business as keeping a good business credit score.
- You do business in a sketchy industry: By sketchy, I mean, highly volatile or erratic. Just like some banks specialize in particular types of industries, they will avoid others. The restaurant business is a good example. Because so many new restaurants fail many banks avoid lending to restaurants at all. If you do business in a highly niche or volatile industry you’ll either need to bootstrap your funding for the first few years to demonstrate that your business is viable before you’ll have any success at the bank, or try to find a bank or banker that specializes in lending to companies like yours. You might have to bank out of town (or even in another state), but building a banking relationship with a bank and banker that really understands your business is a good idea and technology, in many cases, pretty much makes bank location irrelevant anyway.
Does this mean that you’re stuck among the 90 percent that walk out of the bank empty handed? Not necessarily. There are a lot more options today for small business financing than just a few short years ago. What’s more, competition among alternative financing is making rates and other terms more and more favorable for small business owners. Of course even alternative lenders are interested in how long you’ve been in business, your personal credit, and your industry—they are simply willing to accept more risk. You should also be aware that the cost of capital could be a little higher with an alternative lender. Consider it the cost of being a little more risky loan than what your local banker might accept.
At Lendio, we match thousands of small business owners to financing every month—some even end up with a local bank. Francis Bacon said, “Knowledge is power.” Knowing what your banker is looking for and what might be a cause for rejection makes it possible for you to demonstrate you have a plan to either mitigate his or her concerns or help you focus on an alternative funding source that might offer a better chance for success.
Small business evangelist and veteran of over 30 years in the trenches of Main Street business, Ty makes small business best practices, tips and advice accessible by weaving personal experiences, historical references and other anecdotes into relevant discussions about leading people, managing a business and what it takes to be successful. Ty also shares his passion for small business every week on Forbes.com.