Small business is booming, but you’d never know it judging from small business loan approval rates. Although the economy is rebounding from the 2008 financial crisis, not much has changed for those seeking small business loans from traditional banks. At just 21.3 percent approval rate in January 2015, less than a quarter of small business loan applicants receive their loans.
So, what kind of shot do you have at securing funding? And do you even qualify for a small business loan from a traditional bank? We’ve got the answers. Here are the types of small businesses that typically do not qualify for small business loans from traditional banks:
- Sole Proprietors – There are more than 28 million small businesses in the United States, and a whopping 23 million of them are sole proprietors. Unfortunately, if you’re a sole proprietor, the numbers aren’t in your favor. Traditional banks view sole proprietors as high-risk because there is a greater chance the loan will not be repaid due to lack of income, death, or incapacitation.
- New Businesses – Banks typically want to lend to established businesses. Although they encourage business owners to apply for loans during their startup phase, they really prefer to work with companies that are at least two years old. Statistically, a large number of businesses don’t survive past their first year of business, so once you hit the two-year mark, traditional banks take you a bit more seriously.
- Industry-Specific – The type of business that you own and the industry that you fall under can be a deciding factor for many banks. In some cases, banks have chosen to reject loans solely based on a business’ industry.
- State-Approved Businesses – There are types of businesses that are authorized at the state level, yet lack legitimate state recognition. For example, cannabis shops or marijuana distributors are highly unlikely to receive a loan approval from a traditional bank.
Business Loan Denial Reasons
Traditional banks generally look at very matter-of-fact figures when analyzing whether to approve a small business loan. Here are some of the most common reasons banks give small business applicants the ax:
- Credit History – A strong credit history is a non-negotiable to banks. Without a good personal and business credit score, your chances of securing a small business loan from a traditional bank go from small to virtually nonexistent. Banks will look into both your personal and business credit history. On average, banks like to see a personal credit score of 680-720 and a history of strong money management skills, such as effective management of the business budget and/or personal finances.
- Losses on Tax Return – Showing profit is important in general, but it’s especially important for banks. In the beginning, many small businesses opt to maximize deductions. However, there is a high likelihood that a bank will reject a loan application if the small business doesn’t show a net profit.
- Lack of Current Cash Flow – Banks fear that a business will focus on paying off expenses rather than paying off a loan, so lack of cash flow is a red flag. Banks tend to view a negative cash flow as a representation of a business’ health.
- Insufficient Collateral – Traditional banks prefer to work with businesses that have collateral because if the business defaults on the loan, the bank can acquire the collateral and sell it to recoup the loss. This is another catch-22, though. On the one hand, banks require new small businesses to provide collateral when applying for business loans. The problem is that startups usually don’t have collateral such as vehicles, real estate, investments, or business equipment. If serving up your business or home as collateral scares you, there are many options to get a loan without collateral.
- Customer Base – Banks like to grant loans to industries they consider stable. If they view your customers as a targeted niche, they may reject your loan application. Generally, they prefer to work with a business that has a diversified portfolio of clients.
Ok, so you fall into one (or all) of the categories mentioned above. Does that mean you should give up, call it quits, and live off ramen for the rest of your life? Absolutely not. While traditional banks may make you feel like your business isn’t worthy of their trust, there are other options. Alternative lenders use data and technology to review your business health and approve loans instantly and online.
This article was originally written on August 14, 2015 and updated on March 23, 2023.