Debt financing has long been a preferred financing option for small business owners. It’s true that the majority of entrepreneurs leverage their own money to start or run their business, but those funds often fall short of the ultimate need. In these cases, a business loan gives you more control than you’d get with other routes such as angel investors or borrowing from family members.
However, lenders reject the majority of business loan applications. Rather than letting this reality deter you, it should merely encourage you to put your best foot forward whenever submitting an application. There’s no shame in getting denied by a lender. It happens to everyone. What matters is that you try your hardest and put your business in the best position to succeed.
Here’s a closer look at common reasons loan applications are rejected. Some are easily remedied, while others take more effort. The important thing to note is that none of these factors is a death sentence. If you find that one of them contributed to a rejection, simply make a goal to improve it for your next application. With this focus on incremental improvement, anything is possible.
Here are some of the most likely reasons an application gets axed:
You Botched the Application
One of the biggest contributors to loan rejections is also among the most basic: the applicant didn’t handle the process correctly. This includes leaving sections of the application unfinished, entering incorrect information, or failing to include the required documentation.
You can reduce the risk of this fate by preparing your documents ahead of time. You’ll find it’s much easier to write a business plan or locate your tax returns when you don’t do it the night before the deadline.
Put yourself in a lender’s shoes and it’s understandable why they’re sticklers for details. Because lenders make informed decisions based on the contents of your application, forgetting to complete a section, including erroneous information, or neglecting to send the required documents makes their decision much easier. If you can’t be trusted to fill out an application correctly, how can you be trusted with a large sum of money?
Imagine if a friend asked you to borrow money but had no clear idea what they would be spending it on. That kind of disorganization would probably be met with a polite rejection from you. Most people only loan money to a friend if they trust them and have an idea of where the money is going.
Your Credit Score is Lacking
Credit scores result from an algorithm that lenders use to predict how likely you are to repay the money they might provide to you. The determinants of your score come down to relevant factors such as how promptly you pay your recurring bills and how much of your credit card balance you pay off each month.
Business owners have 2 types of credit to watch: personal and business. That’s right—your business has its very own credit report and credit score from Equifax, Experian, and Dun & Bradstreet, the 3 major business credit bureaus.
A low credit score can stem from a history of late payments, unpaid tax liens and judgments, or high use of available credit. But lenders can also ding you for not having established a long enough credit history.
Just because your score isn’t where it needs to be for one loan doesn’t mean you’re out of luck. Each lender has their own standards and they generally aren’t shy about broadcasting them. So when you see credit score requirements associated with a loan, take them seriously. You’ll save yourself a lot of time by not chasing loans you aren’t qualified to receive.
You can turn around a low score by paying down debt, paying your bills on time, and keeping your account balances low. If insufficient business credit is the issue, Credit Karma recommends taking the following actions to establish a credit history:
- Apply for and use a business credit card.
- Open a business bank account under your business name.
- Get a business phone under your business name.
- Apply for an employer identification number (EIN) from the IRS.
- Register your business with Dun & Bradstreet to get a free DUNS Number.
Taking these steps—and being consistent—can help you improve your business credit score so you can qualify for financing, maybe even at a better rate.
Your Business is Too Green
Every business needs to start somewhere, and there’s no shame in being a young company. It’s actually something to be proud of because it takes determination to turn your idea into a reality.
But many lenders will be understandably skittish when dealing with businesses that lack a track record. The success rates of a company 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 ability to repay your debt is substantially impacted by the amount of money your business brings in, so the more evidence of cash flow you can provide, the better. And for young businesses, this type of evidence is in short supply.
You Need More Collateral
Many small business loans are secured loans, meaning you need to offer something of value to protect the lender in case you aren’t able to make the necessary payments. Assets used for collateral include vehicles, homes, properties, equipment, and retained income.
Lenders prefer borrowers who have skin in the game—assets offered up as collateral, which the borrower would forfeit if they defaulted on their loan. Before you reapply for financing, document all of your personal and business assets, such as equipment, bank accounts, real estate, vehicles, and even accounts receivable, and then decide which you’d be willing to use to secure a loan. As you work through the list, consider your likelihood to default and what the consequences would be if you had to forfeit the assets.
When you lack an adequate asset to use as collateral, you’ll find that lenders are more likely to turn down your applications. While this can be frustrating for borrowers, it makes sense. If lenders always handed out money without guarantees, it wouldn’t be long before they’d run out of it.
Your Cash Flow is Lacking
When lenders want to quickly assess an applicant, they often start with cash flow. Not only does it show the strength of your business performance, but it provides a glimpse into your ability to manage details and stay on top of expenses.
If your business is new, it often lacks the track record needed to instill confidence. The good news is that certain loan options are ideal for newer businesses. Just make sure your business tenure lines up with the requirements for a specific loan before you apply. Some businesses experience seasonal slumps, which is understandable to lenders. What they’ll want to see is that you can balance your financial obligations year-round. Accounting software makes this easier to accomplish by tracking invoices so you can collect payments promptly. Also, this type of software can quickly create cash flow reports for loan applications.
You Went for the Wrong Loan
There are times when a borrower has all their ducks in a row, yet they’ve simply applied for a loan that isn’t a good match for their business. Perhaps your business doesn’t qualify due to its size or structure, or your business plan calls for using the money in ways the lender doesn’t approve.
The point is that your due diligence needs to take into account the nuances of each lender so you don’t waste time applying for a loan that will never be possible for your business.
Banks look at your debt-service ratio to determine whether you’ve got enough cash flow to make the loan payments. To calculate the ratio, take your annual net operating income and divide it by your annual debt payments. Higher numbers are better. You’ll need at least 1.15 for a Small Business Administration (SBA) loan guarantee, and lenders could require a stronger ratio. Next time you apply, run your anticipated loan amount through an online loan calculator to make sure you’re not overreaching.
At the other end, it’s just as much work for lenders to extend a large loan as a small one, but they make more money on the large one. If you’re finding yourself feeling pressured to apply for more than you need just to qualify, consider alternative sources of financing, such as crowdfunding, angel investors, or an SBA microloan.
Your Business Plan is Underwhelming
Many lenders ask for business plans as part of the application process. They’ll review your plan to see how you intend to spend their money, as well as to gauge your organizational and strategic abilities.
Writing a business plan speaks volumes about whether your company is a good investment, and it’s one of the primary tools lenders use to evaluate business loan applications. If yours wasn’t up to snuff the last time you applied for a loan, take the time now to whip it into shape. In addition to descriptions of your company and its structure, your product or service, and your sales and marketing plan, the SBA recommends that you present the following:
- A market analysis
- Financial projections based on your income and cash flow statements, balance sheets, and budgets
- An appendix with documentation supporting your application
Applying for a business loan is never easy, but it’s preferable to letting cash-flow issues keep your company from growing. By shoring up your credit, keeping your requested loan amount realistic, and wowing lenders with a business plan that shows you and your company in the best light, you’ll maximize your chances of getting the funding you need to take your business to the next level.
Never rush this stage of the application. Your business plan is your sales pitch, as well as your guiding light. If done correctly, it will sufficiently impress the lender so that you can obtain the financing you require. Once you have the money, it will then serve as your blueprint for spending it in the most effective way possible.
Your Financial Statement are Lacking
Not having accurate, informative, timely, accessible, and comparative financial data will hurt your chances if you need to raise money and get a business loan, underscoring just one of the reasons to make sure this part of your business is handled professionally. Here are the most common errors and pitfalls that will hinder your business from raising funds:
Revenue Recognition
Actually “earning” your revenue is almost never directly correlated to when you send an invoice to or receive money from your customers. Each industry has one right and many wrong ways to recognize revenue, and bankers and sophisticated investors will be familiar with each. If you are a software company and the banker does not see that you have an account called “Deferred Revenue” on your balance sheet, for example, they will lose confidence in your ability to run your business.
Gross Margin
There are two main expenses in a business, and they should be separated on your profit and loss statement. Specifically, all expenses directly related to the manufacturing of your products or the fulfillment of your services, also referred to as costs of goods sold or cost of sales, should be subtracted from your net revenue (correctly recognized as mentioned above) to determine your gross profit. Then divide your gross profit into your net revenue to find your gross margin. Many businesses fail to show this separate from the rest of their expenses and net profit before taxes, but it is a number bankers and investors want, and need, to know.
Balance Sheet Reconciliations
Every single account on your balance sheet should be reconciled every month, not just your bank and credit card accounts. This includes a thorough review of your accounts receivable, inventory, accounts payable, payroll liabilities, inter-company loans, and more. You need to be able to explain to a banker or investor what each account represents and even be able to provide documentation, upon their request, to validate the balance reflected on your balance sheet. Too many businesses pay little or no heed to their balance sheet, but investors and bankers know it drives the accuracy of everything you present in your financial statements.
Lack of Metric and Ratio Knowledge
You need to know your numbers, and, even more importantly, you need to know what they mean in the context of your past, future, and industry as well as the perspective of bankers and investors. Bankers care about current ratio, days sales outstanding, working capital days, inventory turnover, fixed charge coverage ratio, and other proofs of your liquidity, stability, sustainability, and wherewithal to pay them back. Investors care about EBITDA, free cash flow, burn rate, and other things dealing with the cash required to grow the business and the potential return their investment may garner.
Your Debt Utilization Raises Red Flags
Lenders will pay close attention to the credit currently available to your small business. If you’re using too much, it could mean you are already stretched thin and might not be able to handle your repayments consistently.
On the flip side, if you haven’t utilized credit in the past, you could be considered a risk because you won’t have a debt track record from which they can base their decision. If you have a healthy amount of credit available and are only using a moderate amount, that puts you in the safety zone. It shows you have responsibly borrowed money in the past and know how to handle the repayments.
You Don't Have Any Income
Unlike an equity investor who will reap the rewards of their investment when a business is either sold or goes public, the first loan payment will likely be due somewhere around 30 days after a business owner receives the proceeds. In other words, if there isn’t sufficient income to make the loan payments, it’s unlikely the lender will approve the loan.
Your Loan Isn't Cost-Effective for the Lender
Don’t forget that it costs money to lend money. So if you apply for a small loan from a larger lender, they might see it as more effort than it’s worth. There are plenty of financing options for small dollar amounts, but you need to make sure you’re approaching the right lenders.
The Best Way to Begin Your Loan Search
Many of the mistakes listed above involve carelessness on the borrower’s part. They didn’t research the lender well enough or they didn’t carefully prepare their application. So pump the brakes a bit and take the time to understand your financial needs and identify the exact amount of money you’ll need to borrow.
According to the SBA, the median small business loan in America is $140,000. And the majority of loans are for less than $250,000. These numbers don’t necessarily mean you should follow the trend and ask for $140,000, but it provides a helpful baseline as you decide on the best amount for your needs. Use our SBA loan calculator to estimate your monthly payment and how large of a loan you can afford.
Another crucial factor is when the funds will be in your account. If you need the money right away, you’ll need to look at a small selection of expedited loans. If you have a more generous timeline, you can probably seek out slower options such as SBA loans (which can take up to 3 months to fund).
How to Recover from a Rejected Loan Application
First of all, don’t get discouraged. Only about 1 in 10 applications for small business loans are approved. It’s incredible (in a bad way) that 9 out of 10 business loan applications are rejected.
Having your loan application rejected is a wake-up call that your credit or business health isn’t as strong as you thought (or hoped) it was. It can be a very demoralizing experience—especially if you were counting on that financing to sustain your business operations.
When a loan application is denied, it can usually be traced back to two explanations: bad credit or a high debt-to-income ratio. Fortunately, both of those things can be fixed with responsible practices and a little patience, making you more likely to get a “yes” the next time. Here are 6 things to do as soon as your loan application is denied.
1. Study your rejection letter
All lenders are required by law to send you a written notice confirming whether your application was accepted or rejected, as well as the reasons why you were turned down for the loan. According to the FTC:
“The creditor must tell you the specific reason for the rejection or that you are entitled to learn the reason if you ask within 60 days. An acceptable reason might be: ‘your income was too low’ or ‘you haven’t been employed long enough.’ An unacceptable reason might be ‘you didn’t meet our minimum standards.’ That information isn’t specific enough.”
Understanding the “why” of your rejection helps you know where to focus your efforts, whether that means paying down your existing debt or building more credit history. So, instead of balling up the letter and tossing it into the trash, turn your rejection letter into your new plan of action so that you can be more credit-worthy down the road.
2. Address any blind spots on your credit report
Ideally, you should check your credit report three times a year, looking for old accounts that should be closed or inaccuracies which could suggest identity theft. But with so much on your plate as a business owner, keeping up with your credit can sometimes fall by the wayside.
That becomes a real problem when your loan is rejected for reasons that take you by surprise. Credit reports don’t just summarize your active credit accounts and payment history; they also collect public record information like bankruptcy filings, foreclosures, tax liens, and financial judgments. If any of those things are misrepresented on your credit report, it can be tremendously damaging to your chances of securing credit.
Whether inaccuracies occur due to malicious act or accident, it’s ultimately up to you to stay on top of your own credit. Access your credit report for free on AnnualCreditReport.com, and file a dispute with the relevant credit bureau (either Experian, Equifax and TransUnion) if you see anything shady on the report they provide. As credit.com advises:
“If you see any accounts you don’t recognize or late payments you think were on time, highlight them. You’ll need to dispute each of those separately with the credit bureau who issued that report. Even if the same error appears on all three of your credit reports, you’ll need to file three separate disputes over the item.”
3. Pay down outstanding balances
One of the most common reasons for loan rejection is credit utilization—the ratio of your current credit balances to credit limits. This is slightly different than your debt-to-income ratio, which divides your monthly debt obligations by your monthly gross income. Both measurements reflect how much additional debt you can afford to take on, so the lower these ratios are, the better chance you have of being approved for a loan.
Being denied a loan due to your credit utilization or debt-to-income ratio means that lenders aren’t fully confident that you’ll be able to make your minimum payments. There’s nothing to do here except take your medicine: put your new financing plans on hold and focus on paying down your balances until your debt-to-income ratio is below 36.
4. Beware of desperate measures
If you applied for a loan to stave off financial hardship, being turned down can create panic that can lead to some very bad choices. Predatory lenders make their living on that kind of panic, and their risky, high-interest loans almost always leave you worse off than before.
Predatory lenders offer financing that is intentionally difficult to repay. Through their extremely high interest rates, unreasonable terms, and deceptive practices, these lenders force desperate borrowers into a “debt cycle,” in which borrowers are trapped in a loan due to ongoing late fees and penalties. Two of the most common predatory loans are:
Payday loans: These are short-term loans with interest rates typically starting at 390%. (No, that’s not a typo.) A borrower provides the lender with a post-dated check for the amount of the loan plus interest and fees, and the lender cashes the check on that date. If the borrower doesn’t have enough money to repay, additional fees and interest are added to the debt.
Title loans: The borrower provides the title to their vehicle in exchange for a cash loan for a fraction of what the vehicle is worth. If the borrower is unable to repay, the lender takes ownership of the vehicle and sells it.
Please don’t go this route. If your loan rejection has left you desperate for money, swallow your pride and try to borrow from friends and family instead.
5. For thin credit, start small
Being turned down for an “insufficient credit file” doesn’t mean you’re irresponsible—it simply means you don’t have a long enough history of credit maintenance and payments for a lender to make a confident decision about your creditworthiness.
While this situation is very rare for established business owners (who generally have years of credit card and vendor account payments under their belts), young entrepreneurs might not have a long enough credit history to secure the financing they need. If that’s the case, you’ll have to go through the motions for a while: Opening a couple of small credit accounts with easy-to-manage payments will prove to lenders that you have your finances under control.
The Consumer Financial Protection Bureau recommends two low-risk options to build up your credit file: Secured credit cards, in which you put down a cash deposit and the bank provides you with a credit line matching that amount, and credit builder loans, in which a financial institution deposits a small amount of money into a locked savings amount, and you make small payments until you come to the end of the loan term and receive the accumulated money.
6. Wait for the right moment
When you authorize a financial institution to check your credit for a loan application, it typically creates a “hard inquiry” (or “hard pull”) that stays on your credit report for two years. This is different from a “soft inquiry,” which is more commonly used in background checks and pre-qualification decisions, and has no impact on your credit. (Some alternative lenders only use soft inquiries during your application and funding process, so it’s important to find out up front if your lender will be performing a hard credit pull, a soft pull, or both.)
Each hard inquiry won’t affect your credit score much on its own, but multiple hard inquiries in a short period of time can be a major red flag for lenders, who may interpret those inquiries as a sign of financial instability or desperation.
When you’re turned down for a loan, your first instinct might be to immediately apply for a loan elsewhere, in order to get a “second opinion.” The problem is, you may be even less likely to be approved for that next application because you’re racking up hard inquiries on your credit report.
Our advice? Don’t apply for another loan until you’ve made significant improvements to your credit and financial health—a process that can take a year or more. The longer you can wait, the better.
Where to Go When the Bank Says No to a Small Business Loan
After you’ve improved your credit and financial health, you’ll be ready to look for financing options again. When looking for a small business loan, whether for expansion, short-term expenses, or any other, you have more options than just checking with your local bank. Banks and other conventional loan providers have certain criteria when approving your loan. They take into consideration many factors such as the time for which you have been in operation, credit scores, the monthly revenue you earn, your business plan, and the collateral you can provide, among others. If you’re unable to meet their conditions, they may not offer you the finance you need. In such a situation, your best bet is to look to alternative or innovative lending institutions such as Lendio to obtain the funds. Here are some of the best options out there.
SBA or Small Business Administration Loan Programs
The SBA has several small business loan programs for small enterprises, intended to meet their finance requirements. While the government does not lend directly to the companies, it works with microloan providers, banks, and other community development institutions. It supports entrepreneurs by laying down certain regulations for the lending procedures.
- SBA 7(a) Loan Program: A very versatile program, it allows start-ups and small businesses to use these funds for buying machinery, tools, furniture, and other equipment, working finances, buying and renovating fixed assets like structures and other property, among others.
- Real Estate and Equipment Loans: You can use the financing provided under this program only for expansion purposes and to buy land, existing structures, developing, renovating, and constructing buildings, and machinery for use on a long-term basis.
- Microloan Program: By way of this program, small business owners cannot buy fixed assets or pay off loans. They can only use the funds as working capital or to purchase small machinery, tools, and other fixtures. You can also buy inventory, furniture, and other supplies you need.
- Disaster Loans: If you’ve lost property and real estate, inventory, machinery, equipment, or any other supplies in a declared disaster, you can use the business loans provided under this program to replace them. This program offers finance at low interest rates.
Alternative Finance Sources
Aside from banks and the SBA, there are many other sources for getting the funding you need. Look around for the many lending institutions that offer you a small business loan without the strict criteria that banks have. They may be open to providing you business loans despite low credit scores, lack of collateral, or insufficient monthly revenues. However, you might have to pay much higher rates of interest and typically, small business loan terms are shorter than those offered by the SBA. Here are some of them:
- Lending Club: You can borrow funds of up to $35,000 from the other members if you have a credit score of a minimum of 650. Other members lend you the finance you need and can earn up to 9% in interest.
- Prosper: The maximum loan amount offered is $25,000 and borrowers with credit scores of a minimum of 640 can access funds. Lenders can provide loans in smaller denominations until the total amount is raised.
- OnDeck Capital: You can access funds from this source if you can prove that you have been in business for a minimum period of a year and have an annual revenue of $100,000. Apply for the business credit you need over the phone or by filling an application form online. OnDeck makes the loan amount available to you within a day or more.
- Communities At Work Fund: if you can meet their criteria and run a non-profit undertaking, this finance institution extends the funding you need. They direct their support to businesses with low-income and communities in the lower wealth category.
- Accion: Depending on certain conditions, you can get financing of a maximum of $50,000 if you have a credit score of at least 525. At the same time, you must prove that in the last one year, you have not declared bankruptcy and have enough monthly earnings to clear your bills and make payments towards your loan.
Crowdfunding Loans
Crowdfunding loans are similar to microloans, and small business owners that cannot access bank finance can make use of them. However, like microloans, you won’t need to pay back the loan amount in cash. Instead, you’ll need to honor the loan obligation in other ways.
- Kickstarter: This institution issues loan products to companies or creative entrepreneurs for expansion purposes. While you’ll remain the owner of the products you create, you’ll need to prove that your enterprise has the total funding to get started. In lieu of the loan amount, you’ll pay in the form of a product or service your company offers. For instance, if you’re planning to open an art academy, you might have to submit saleable art to pay for the loan.
- Indiegogo: The terms and conditions for accessing this funding are similar to that of Kickstarter. However, you don’t need to have the complete start-up finance in hand to qualify for the business credit.
Entrepreneurs and owners of startup companies no longer need to rely on banks to get the business loans they need. Nor do they need to wait for long processing times and submit elaborate paperwork to get approved. Instead, they can contact many other lending institutions and get the small business loan products they need at terms and conditions that are more suitable for their enterprise and its unique needs.
Lendio is a free marketplace for small business loans. Simply answer a few questions about your business and the amount of capital you are seeking. Lendio will instantly match you with loan options from our network of over 50 lenders. Lendio makes it possible to shop for the best business loan options and rates available without having to submit your information to multiple banks and organizations.
With all of these strategies, it’s helpful to put yourself in the lender’s shoes. Their job is to simultaneously fund small businesses and also safeguard their money. It’s a difficult balancing act, and they likely take no pleasure in rejecting applications. You can make things easier for both them and you by carefully preparing each application and ensuring that you’re giving them ample reasons to give you the green light.
If your loan is approved, throw a little party with your friends. If your application is denied, don’t despair. Remember, the majority of loans are met with a hard no. Take positives from the experience by learning from your mistakes and submitting an even stronger application the next time around. This approach ensures you’ll always be progressing and you’ll eventually get the financing your business requires.
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