Small businesses need access to financing to grow and make the operational improvements required to remain competitive. Despite that many traditional and online lenders advertise that they’re willing to loan to small businesses, one recent survey revealed that 45 percent of business owners have been rejected for a loan more than once. Further, nearly a quarter of them don’t know why they weren’t approved. Here’s a look at some of the most common reasons businesses get rejected for loans.
Credit score issues
Not all lenders base financing decisions on credit scores, but many do consider business and personal credit history as part of the criteria that determines whether they’ll approve a business loan. (In a perfect world, your business will have its own credit history — and score — so you don’t have to co-mingle your personal finances into your business). Try to proactively build your business credit history as soon as you open your doors:
1. Apply for credit terms with vendors you purchase business materials and office supplies from regularly
2. Establish business bank accounts with financial institutions that also issue credit cards to small businesses.
3. Use no more than half of the credit line(s) you’re offered; pay them off in full each month by the payment due date. You’ll avoid paying interest rates and related fees, while building a formal credit history that will substantiate your business’s credit worthiness when you’re ready to apply for a loan.
Once your business has had active and open lines of credit for about one year, check your credit report with a credit reporting bureau such as Experian or Dun & Bradstreet. Ensure that the information on your report is accurate (and positive). This is the same type of information potential lenders may see when you apply for a small business loan.
Lack of cash flow
Though many small business lenders have reduced the importance they place on credit scores in an effort to be more small business-friendly, they assume a level of risk when lending to a business that lacks an established history of repaying loans. In lieu of this documentation, business lenders may rely on a business’s cash flow to gauge how financially equipped a borrower is to repay a loan.
Before you apply for a business loan, try to optimize cash flow:
- Invoice customers as soon as work is complete.
- Use automated invoice systems to deliver electronic invoices and reminders of upcoming payment due dates.
- Impose late fees on past-due invoices.
- Offer early payment discounts.
- Encourage customers to pay with credit or debit cards instead of checks, which may take several days to clear.
- Manage monthly expenses.
Your industry is high-risk
Some industries are inherently considered riskier than others, often due to factors such as legal and regulatory standards. If your business operates in some facet of financial services, real estate services, alternative medicine, or is a bar or nightclub, lenders could view your business as one that presents more risk than they’re willing to bear.
Your business isn’t established
You may be a fortunate entrepreneur whose business is an instant success, but many lenders want to see proof that you can replicate that same level of performance for several years. Some online lenders may require that your business have at least a year under its belt, while more traditional lenders such as banks and credit unions may want to see at least three years of stable and consistent financial performance.
Businesses get rejected for loans for a variety of reasons, but it ultimately comes down to the lender’s perceived risk. The more you understand about the factors that lenders use to approve loans, the more you increase the chances that your search for financing will be seamless.