A small business loan rejection can be a nightmare for some business owners. After all, you need that loan to grow your business, but the bank says no. However, if you find yourself in this position, you are far from alone. In Lithuania, for instance, 29% of small businesses reported rejection of loans in 2021, the highest rejection rate in Europe.
Several factors can lead to a lender’s refusal of your business loan application. But you can prepare for them by learning about the common red flags a lender looks for. This article covers the reasons and strategies for getting approved for small business loans.
Want to know more about all things related to studying or being an entrepreneur? Then sign up for our EWOR platform and gain access to over 17 courses and a plethora of resources.
Understanding Your Credit Score
A bank evaluates your creditworthiness by analysing your credit score. In many cases, lenders determine whether to approve or deny your loan application based on your credit score.
Banks may reject your loan application because bad credit scores mean a history of missed payments. Due to their young age, small businesses rarely have established a good credit history. And so it can be hard for them to get bank loans.
Any small business loan application requires a good personal credit score as well as a good business credit score. A good credit score reflects your ability to repay debts and maintain monthly expenses.
Each lender will have a different credit score requirement for a business loan. Banks typically require 660 or higher, while alternative lenders may require 520 or lower. Nevertheless, a low credit score means a higher probability of rejection.
Here are some tips for overcoming this challenge:
- Make your loan payments on time.
- Don’t exceed your credit limit when spending.
- Keep accounts open, since some lenders may find it difficult to lend to you if you have no credit history.
- When applying for your first business loan, ensure your personal loan has a good credit score.
Develop a Solid Business Plan
Another reason banks reject small business loans is a lack of a solid business plan. Business plans are formal explanations of your business goals and steps to describe how you plan to achieve them.
Owners applying for small business loans often do not have a formal business plan. However, lenders aren’t impressed by an owner without a plan or with just a quick sketch. Poorly prepared business plans can make lenders second guess your application if they lack the details. Consequently, your small business loan is denied.
Designing a solid business plan will help you convince your lender that you are capable of repaying the loan by the maturity date. Lenders will have more confidence that you won’t go bankrupt before you’ve finished paying back the loan if you demonstrate a clear growth direction.
Registering your business name correctly is also important. In order to obtain a small business loan, you must register your business.
The steps you need to include for a perfectly written business plan:
- Synopsis: The purpose is to give a brief overview of your business. This should describe what you aim to accomplish, how you plan to accomplish it, why funding is needed, and how it will contribute.
- Description of your company: Give an overview of your company and what you plan to achieve within the next 3 – 5 years.
- Services/Products you offer: Describe what you offer in terms of products or services. Also describe what makes it different from your competitors and how it fills a need for your customers.
- Evaluation of the market: Give a brief description of your industry, your target market along with your competitors.
- Key Resources: Provide a list of the resources your idea will require.
- Channels of Marketing: Describe how you intend to reach out to your customers/target audience.
- Obtaining Funding: Provide an estimate of the amount of funding you will need and how you will use it.
- Sources of Revenue: Provide a breakdown of your revenue and costs in a specific period, and explain how much you expect to earn.
Interested in creating a successful business model for your new business idea? Check out this guide to learn how.
Documentation/Paperwork Should be Accurate
Not filling out the application correctly or not providing all the necessary backup information is one of the most common reasons that a small business loan application is denied. A well-planned business plan and a strong credit rating still cannot guarantee your acceptance.
The truth is, business owners often spend 20-30 hours on loan applications, so it’s hard to blame them if they were denied. A business loan application can be a tedious process. It becomes even more frustrating when you have to deal with the heaps of paperwork that some lenders require.
As a lender evaluates your business and decides whether to approve your business loan, they will require a number of financial and legal documents. Lenders and banks ask for this information for a reason.
By analysing each document, the lender can assess your company’s risk level and decide whether it is a good investment to lend you money.
Here are some steps you might find helpful for preparation:
- Once you’ve completed your loan application, double-check the details by going over it line-by-line.
- Preparation and organisation of your documents are essential.
- It is essential that you track down and submit all tax returns, bank statements, business licences and other documents the lender requests.
- It might be possible for you to qualify if you follow up on every request.
Secure a Collateral
A collateral is any type of real estate or equipment that relates to a business or personal property. Normally, banks will require collateral from borrowers before giving them a loan. Collateral serves as a guarantee that the loan will be repaid.
Many banks determine what they can lend based on the collateral they receive. When a business lacks infrastructure, new business owners may have to use their homes as collateral.
The risk of using personal property as collateral is it can be sold to repay your loan if you fail to repay it. Thus, small business loans are challenging, especially for those without valuable assets to pledge.
To overcome this challenge, you can follow these steps:
- Before applying for a small business loan, you might want to wait until you own tangible assets, such as houses or other properties, before you seek a secured loan.
- When determining what property you are willing to put up as collateral, take inventory of your property in light of the risk of losing it if a loan default occurs.
- As a next step, create a collateral document detailing the specific properties you will use to secure the loan, along with their values.
- If you don’t have a collateral, other funding options, such unsecured loans, can be used.
Cash Flow Management
A business’s cash flow refers to how much cash comes in and goes out. In the absence of sufficient cash flow, your business may be unable to make monthly payments on new debt. Your business’s ability to function daily depends on it, too.
If you are applying for a small business loan, you might run into trouble if you have limited or inconsistent cash flow. For a lender to approve your loan application, make sure that your business can meet payment requirements, manage unexpected disturbances, and cover everyday expenses.
The lack of cash flow in your business is a sign to lenders that you’re unusually risky – and you may have difficulties securing the financing you need. As a result, owners applying for small business loans often face difficulties due to poor cash flow.
Before approving an application, lenders want to see that a business’s cash inflow is greater than its outflow. Lenders prefer businesses to have consistent cash flow, even if it is not always possible. For this reason, a good cash flow management strategy is important for running a business and obtaining a loan as well.
With the following tips, you can manage your cash flow effectively:
- Immediately after you deliver products or services to your customers, ensure that your company sends out invoices.
- Keep invoices up-to-date by collecting payments from customers before they lapse.
- Considering charging a late payment fee for past-due invoices might create a more consistent follow-up process.
- If your company offers multiple products or services, make sure you document all income streams.
- Make use of accounting software that allows you to create cash flow reports and projections easily.
- You should monitor your cash flow weekly to ensure that you are on top of things.
Can Small Businesses Ever be Rescued From Loan Rejection?
The bottom line is that being denied financing for a business is a setback, but it doesn’t mean that you are unable to succeed in business. There are still other business financing options available. Discover the probable cause for your loan application being denied and what steps you need to take as a result.
Not sure how to improve? Don’t hesitate to contact the lender to find out how you could have improved. Then consider this information when applying next time. It is crucial to choose the right lender when applying for a small business loan, just as lenders make loan decisions.
Showing the lender your sincerity by presenting complete and accurate requirements shows that you take your loan seriously. Make sure lenders know you’re putting your heart and mind into your business, and that you’re determined to provide the best service possible to your customers.
Keep these things in mind during the lender interview, and you’ll be on your way to approval. Be sure, however, not to let your enthusiasm fade away once you have received your funding. It should carry you through to the end of your success quest.