This is a pretty simple question with a more complicated answer. There are a lot of reasons why a business loan application might be denied, but what most small business owners should be asking themselves is, “What can I do to improve the odds of a successful loan application.”
Lenders are basically trying to answer three questions:
- Can this borrower repay a loan? Does this business have the financial means to make each and every periodic payment? Without adequate revenue and cash flow it’s difficult for a lender to approve your loan.
- Will this borrower repay a loan? This is a different question and why your past credit history is so important. The lender is trying to judge what you will do in the future based upon what you’ve done in the past. They want to see a track record of successfully making periodic payments because it is an indication that you will do the same with a new loan.
- What if something unexpected happens? Lenders don’t want to see you default and they generally don’t even want your collateral, but they do want to know that in the event you do have problems, there is a way to mitigate their loss. That’s why some lenders require collateral, some require a lien on business assets, and most of them require a personal guarantee.
How successfully you can answer these questions will not only determine whether or not a successful loan application is in your future, it will also determine the type of loan you may qualify for, the lender that will accept your loan application, and the interest rate (or cost) of the loan you’ll be required to pay. In other words, there is no one-size-fits-all small business loan and depending on how qualified the borrower may be, he or she might have more options to choose from than a less-qualified borrower.
Because this is a common question whenever I have the opportunity to speak with small business owners, I thought I would share some of the questions I typically ask them to help determine why their loan application may have been denied.
What Do You Need the Money For?
Why are you borrowing? What is your loan purpose? The question can be asked several different ways and the more specific and deliberate you are in your answer will not only instill some confidence in the underwriter evaluating your application, it will also help you choose the type of loan best suited to meet your loan purpose.
For example, are you trying to fill a short-term need or a longer-term need? That answer alone could make a difference in the type of financing you look for. In much the same way most people wouldn’t purchase a car with a 30-year auto loan, it might not make sense to apply for a 10-year term loan to purchase quick-turnaround inventory that will be in and out of your business in the course of a couple of months.
Some lenders are better suited to meet some business needs better than others. So if you go to the wrong lender, even if you are a good potential borrower, you are likely to see your application declined.
How Much Do You Want to Borrow?
Many times it’s not that small business owners want too much, but rather they ask for too little.
Loan amount is another clue as to where you should look for a loan. Many traditional financial institutions want to lend $500,000 to $1 million rather than $45,000 to $50,000. Because it costs them about the same to underwrite a $1 million loan as it does a $45,000 dollar loan, it’s not hard to understand why they pursue the larger loans from their larger customers.
If you are looking for $15,000, for example, and apply at the local bank, your denied application could likely be attributed to the loan amount you’re seeking as well as your business and personal credit profile. Fortunately, there are numerous lenders ready and willing to offer you the loan amounts many small businesses are looking for.
Your Personal Credit Score Matters
For most small business owners in the United States, your personal credit score is going to be part of every small business loan decision a lender makes. And, if you have a poor score, it is not only going to make getting a small business loan more difficult (though there are options), it’s going to likely make any financing you can get more expensive.
Your personal score will help you determine where you should look. Most banks and credit unions are looking for personal scores in the 700s to approve a small business loan; though they will sometimes go as low as 680. The SBAs minimum threshold is around 650. Lower than that and your SBA loan application will be declined.
Many online lenders will work with a borrower even if they have a personal credit score as low as 600—and some will go even lower, but their interest rates will be higher than the bank or the SBA and their terms will likely be shorter. They will also likely require daily or weekly direct debit periodic payments.
There are even some cash advance providers that will work with a borrower if their personal score is in the low 500s, but the costs of the financing will be much higher for those with a score in that range.
A good personal credit score isn’t really a guarantee that you’ll get the small business loan you’re looking for, but it will provide options that a poor credit score won’t. With that in mind, every small business owner should focus time and energy in building a strong personal and business credit profile that will enable them to borrow when they need to and select from the best financing options for their business.
Your Business Credit Profile Can’t Be Ignored
Business credit is very misunderstood by a lot of small business owners. In addition to your personal credit, your business has a credit history too. The business credit bureaus consider things like how your business makes lease payments, pays for supplies, or makes payments on other business debt. Far too many business owners don’t understand their business credit profile and how important it is to build a strong business credit history.
Start with becoming familiar with your profile and then look for ways to build your business credit. Payment terms from suppliers and business credit cards are both good ways to build your credit strength.
How Long Have You Been in Business?
Your time in business matters because lenders are looking for a track record that indicates your business will meet its financial obligations. That being said, not all lenders require the same thing.
An idea stage startup is probably the most difficult business to fund a loan. Without a track record or any revenue, it’s hard for a business owner to answer the first question, “Can this business repay a loan?”
That doesn’t mean a loan is completely out of the question. The SBA, for example, offers some startup financing for small business owners with excellent personal credit who can demonstrate an income of some kind that indicates they can make regular periodic payments, but those options are rare. And business credit cards are another option for a new business, provided the business owner has good to excellent personal credit.
Most banks want to see several years in business before they will approve a loan, but there are alternative lenders online that will work with your business provided you have a year under your belt. There are even a handful that only require six months in business.
In other words, depending on where you apply, your time in business will impact whether or not you get a loan approval with some lenders—even if your business metrics look good.
Your Industry Matters Too
Some lenders prefer to work within certain industries and will automatically reject an application that doesn’t represent that industry. Some industries are considered to be higher credit risks than others so when you are looking for a lender, many publish a list of restricted industries on their public website so you can determine whether or not your loan application will be automatically rejected or not.
Although some industries that are considered higher risk by some lenders, like restaurants, auto dealers, and general contractors, are considered good customers by others. Your local Chamber Members or industry groups could be another good source of information about who is lending to businesses in your industry. Nav is also a good source of that information and can help direct you to lenders who are interested in working with businesses just like yours.
What Are Your Annual Revenues and Monthly Cash Flow?
This is how lenders try to answer that first question, “Can you repay a loan?” Lenders look at your revenue and cash not only to determine whether you have the ability to repay a loan, your revenue numbers and your monthly cash flow will help them determine how much you will qualify for (think in terms of 50% to 100% of your annual revenue).
Some lenders won’t approve a loan if your revenue is below $1 million annually, but there are others who only require $100,000. Make sure you know what the annual revenue requirement is before you apply for a loan to avoid a rejection based on your revenue.
Is There a Bankruptcy In Your Past?
A bankruptcy doesn’t necessarily mean a small business loan is out of the question, but it will make it much harder to gain a loan approval.
Depending on how long ago your bankruptcy was discharged and what your credit behavior has been since then, it is possible to get a business loan if it has been at least a year since it was discharged (there are lenders that only require six months), but don’t expect the bank to talk to you for at least two to five years. What’s more, if your bankruptcy hasn’t been discharged, a business loan is likely out of the question.
Does Your Business Have Any Legal Judgements?
Most lenders do not look favorably on any legal judgement or the associated liens. Any open liens resulting from a legal judgement will make it harder to get a loan approval, but any judgement over $10,000 is even more serious.
Do You Have Any Collateral?
Not all lenders require specific collateral to secure a loan, but most traditional lenders and the SBA loan guarantee program typically does. The SBA will not always require a borrower to fully collateralize a loan, but they will take all the collateral that you have.
The collateral requirement can make it difficult even for healthy businesses that just don’t happen to have any assets that could be used as collateral to secure a loan from a traditional financial institution.
Fortunately, there are lenders that don’t require specific collateral and instead rely on a general lien on business assets and a personal guarantee (along with most traditional lenders) to secure a small business loan.
You Don’t Need to Be a Financing Expert
You don’t need to be a financing expert to secure the right financing for your business, but you do need to be a little more savvy when it comes to where you look and what you ask for. Better yet, that’s why companies like Nav exist—to help you find the right financing for your business situation.
Nevertheless, answering the above questions will help point you in the right direction and help you improve the odds of a successful application. Remember, there is no one-size-fits-all solution, so you want to make sure you have a good idea of what you’re looking for, how much financing you need, and what your business and personal credit history looks like before you apply.