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Why Do Banks Refuse Loans To Small Businesses?

Jason Smith

Jason Smith

Senior Author

Jason Smith

Senior Author

It’s common practice the world over for small businesses to grow by securing business loans and in realizing their dreams of hitting the big league. In fact, in global corporate history, there have been many instances where a small business started has become a global brand. KFC or Kentucky Fried Chicken is one such name that immediately comes to mind.

Why Do Banks Refuse Loans To Small Businesses?

On the flip side, however, financing a small business may also be incredibly frustrating, especially for a first-time business owner who isn’t exactly aware of the ropes. In fact, a survey conducted recently showed that it’s mostly an uphill battle for a majority of small business owners to readily access capital. The survey actually revealed that more than 45 percent of applicants get turned down more than once, while 23 percent don’t even know why their applications are denied.

The following are usually the reasons why a small business loan application is denied:

Insufficient cash flow

Any lender needs an assurance that a debtor will repay his loan every month, after meeting all operating expenses like payroll, rent, and inventory costs. So, if the business is spending more money each month on these than the revenue it’s earnings, then it needs to solve its cash flow problem first. Once the cash flow problem is solved through prompt invoicing, creation of an emergency fund, instituted late fees and unnecessary expenses cuts, the lender will be more convinced to fund you. Otherwise not.

You don’t understand or know your individual credit score

Sounds ironical but most small business owners aren’t really aware of what their credit scores are.

In fact, 45 percent of such applicants don’t even know that they have a credit score for their business. Additionally, 72 percent of small business owners don't know how and where to get information on their credit scores. Even worse, nearly 80 percent of the smaller business owners admit that they are unaware of how to interpret their individual scores. This drawback is a serious impediment to those applying for loans.

Had they been aware of where exactly they stand in terms of their credibility, then they wouldn’t have applied for a loan at all if their scores were poor, or if they had nil credit worthiness. Once you are aware of where you stand, you can always build or repair your credit through timely payments, keeping debt levels low, keeping all existing credit accounts open and refraining from opening up too many lines of credit.

Limited collateral

Any lender typically won’t risk shelling out funds to a business unless it promises regular returns. In other words, he would want some sort of physical property that may be sold off or acquired if the loan remains unpaid. That’s why creating a detailed collateral document that contains information on everything including both personal and business assets that can be put up as collateral is necessary. Many first time applicants have little or nothing to show as collateral. Thus, their applications are most likely to get rejected.

Early stage startups

It may be a hard fact but most lenders are wary of toddlers in the business world when it comes to giving loans. The fact is any lender would definitely want to see your track record, some credible market experience and obviously, healthy revenues before coming to your aid. Just bouncing a business idea with the prospective lender doesn’t work. But then again, that’s not the end of the road. An early-stage startup has other facilities like online lenders, crowdfunding, small government loans or grants.

Neck deep in debt

Many small businesses in spite of having been around for a while get into heavy debts by way other assorted lines of credit or loans. This puts off any lender when he studies the applicant’s financial status. That’s why it always makes sense to pay off other loans regularly or negotiate with existing lenders to reduce interest rates for paying off outstanding balances faster. Once the lender notices that you have an honest intention to pay off debts, he will be more considerate in sanctioning your loan.

Your business plan is missing

Unless you submit a convincing and solid business plan, don’t expect a lender to oblige you. Without a plan, the lender has no clue about who you are and what you intend doing with the funds he’s going to disburse. Would you loan money to someone who did not have a plan? If you want to see how an idea should be focused on or brought forth you should watch the movie Joy but this is another topic.

So unless that thorough and updated business plan is submitted that clearly states that you’ve conducted appropriate and sufficient research, know your prospective customers well, have a clear vision, mission and goals along with calculated estimates of future sales as also profit projections, rest assured that the loan just won’t come through. Furthermore, your business plan must also be substantiated with details of your personal information, financial and bank statements, income tax returns, and other valid legal documents.

Extremely risky external conditions

A lender’s decision may also be influenced by external conditions. For instance, if a loan is wanted to expand a food delivery service, rising food or fuel costs may make a prospective lender think that granting the loan could be too risky as such soaring costs could always make it difficult for the borrower to earn more profits or perhaps even sustain losses in the long run.

Your reasons aren’t valid enough

It’s also often seen that many first time applicants ask for loans to purchase lavish office spaces or unnecessary business equipment. A lender on assessing your requirement, may refuse the loan if the claim is frivolous. He puts out the funds only when he’s convinced that his money will be used to grow the business so that you eventually pay him back. That’s why applications for reasonable real estate purchases, genuine and essential equipment financing, product and software development, covering seasonal sales variances and advertising, are generally entertained favorably.

The flip side of the coin however, is when a bank refuses a loan, try alternative funding. These may be in the form of merchant cash advances; business loans that range from $5,000 to $500,000; and programs for inventory purchases that allow merchants to buy inventory at nil upfront cost, while the alternative lender funds the full purchase order.

Ultimately, it’s your basic honesty and intention to repay your loan that will convince the lender to oblige you. Keep the above mentioned points in mind and chances are you’ll obtain success.

Jason Smith

Jason is a Senior Author for SBL. He has been working with small business owners like you for the past ten years. He graduated with an MBA and began a career as an independent financial consultant for small businesses in his state. 

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