The process of a small business loan application may be daunting in itself. Though you may conclude that you have all the necessary documents during the application process, the risk of a potential rejection from lenders is possible.
You may ask yourself, “Why is my business loan being denied?” There may be several factors behind a lender’s rejection of your small business loan plan. Here are some reasons why your small business loan application will not get approved.
For starters, you might be approaching the wrong lender. Lenders vary on their criteria when it comes to assessing business loan plans. What may be approved by one lender may be rejected by another. One lender might want to focus only on specific industries or businesses whereas another might favor a broader swath of industries. Preferences for lending to specific geographic regions may also differ among lenders.
Additionally, lenders have their own established standards– known in the industry as “risk asset acceptance criteria” or RAAC. This covers the 5 C’s of credit: Character, Capacity, Condition, Collateral, and Capital. Take note that being rejected by one lender may pose a higher risk of rejection among other lenders. So it is best to tread carefully, gather the right information, and be certain that you and your business are a match to the standards of your intended lender.
Condition of Business and Industry
How you will be making use of your loan will be scrutinized by lenders, especially with regard to the industry and the current condition of that industry. As a business owner, you must be capable of adjusting when need be; operations and finances must be able to adapt to the nature of the industry amidst its peaks and valleys.
As an entrepreneur, you must have a firm grasp on the ins and outs of your business. Ensuring your business will be able to withstand challenging conditions in the industry is crucial in securing a business loan. How your business is positioned to weather any serious adversity within the industry will be an important consideration for lenders as they evaluate your business loan plan.
Lack of Business Plan
Failing to provide a business plan tells lenders that you may be unprepared to manage any loan they will grant you. A lack of long-term plans for your business translates to a lack of knowledge of your particular market, your consumers, and makes any claims you may make about future profits and loan repayments highly questionable.
Insufficient Cash Flow
Inadequate cash flow essentially tells lenders that you may be incapable of paying off a loan on top of balancing other expenses related to running your business to your business. Habitual review and foregoing unnecessary expenses can help your cash flow recuperate. You can also set aside emergency funds to cover any unforeseen but vital expenses of your business.
Some lenders may require collateral when you apply for a business loan. Collateral assures lenders that they can take back any money lost in the event that payment of loan principal and interest by the borrower fails. Inadequate collateral suggests a lack of assurance for the lender that they will be fully paid.
The issue of insufficient collateral may be alleviated by providing a collateral document. This details everything that you can put up as collateral. This may include personal assets or assets from your business.
Lack of Credit History
Seeing as your credit history gives lenders a better understanding of your financial background, a lack of credit history may not convince them to approve your small business loan plan. Without any credit history, lenders may be unable to determine whether or not you can be trusted to pay off a loan. Thus, the consequential rejection.
However, with financial technology, a few startups have designed algorithms based on data that are able to measure the creditworthiness of businesses with “thin credit files” (e.g. CreditPBO.com). These allow for improved financial inclusion.
Too Much Debt
On the other hand, a significant amount of debt in your credit history comes off as a definite red flag to lenders. If your business is already under a lot of debt and operating profit to be used to pay off the debt are lower than the required repayment (or your assets are insufficient to cover the entire loan amount), lenders may become hesitant in extending credit to you and your business. It is thus important that you pay off your existing loans before pursuing a new one so as to improve your standing with lenders.
Requesting Small Loans
It’s important to note that actually asking for a small amount in your business loan may lead towards a rejection of your loan application. This is due to the fact that larger loans are more profitable for lenders and banks in the long run.
For some small businesses, asking for larger loans is out of the question. In such cases, there are alternatives that can be considered, such as turning to a micro-lender or an invoice-based financing option.
Not only will your business will be evaluated, your character and reputation will be looked into by lenders as well. In relation to maintaining quality credit history, it’s important to maintain your reputation as a responsible borrower amongst lenders. Your management of your business’ previous loans will be taken into account when being considered for a new loan. Maintaining a good standing through prompt repayments may boost your character and make you a more reliable borrower for future loans.
Additionally, other details about your professional background and your business experience will also be evaluated by lenders. This may include significant points such as your experience in the industry, capabilities and skills as a business owner, a track record of your personal credit, and education.
Lack of Preparation
In some cases, small business owners may come unprepared to the loan application process. An approved business loan isn’t something that entrepreneurs easily take home. It is important to prepare the necessary documents and forms to provide lenders with the soonest, i.e., the moment you think you will need a business loan at some future time. You will need sufficient time in updating your documents to avoid delays in submissions to lenders. Some of the usual documents required are your business plan, bank statements, financial projections, tax returns, and other relevant legal documents — such as your business permits, licenses, and leases.
Shortage of Capital
Showing your capability of investing in your own business displays your devotion to your business and its growth. A lack of capital is a red flag to lenders as it may tell them that you may be unable to ride out any potential losses for your business should the industry experience any fluctuations. You shouldn’t need to borrow over 30% of the working capital you need just to be able to run your business because no lender will take that risk.
Your credit rating plays a massive role in small business loan plans and their impending approval or rejection Is your score considered good? Is it average? Or is it deemed below the standard? Ultimately, a bad credit rating may be enough reason for lenders to deny you of a business loan. This is why it is crucial that you maintain a good one. A bad credit rating could lead to your business loan being denied; thus, delaying any further progress for your business.
A better understanding of your credit rating and profile of your creditworthiness based on banking standards can improve your chances of securing a business loan. The CreditBPO Rating Report®, its robo-advisory and actionable insights, will show you your credit profile, help you get matched to lenders and be your roadmap to business growth.