No one likes rejection. Whether it’s a ‘no’ from your dream job, someone you love, or the bank, it stings.
And if you’re a small business owner, you might be familiar with this feeling all too well. Of the small businesses that applied for funding in the first half of 2014, only half received an amount, according to a survey by the Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia.
NerdWallet asked loan experts the burning question so many small business owners want to answer: Why are small business owners denied small business loans?
1. Bad credit or no credit
A credit score is a measure of the creditworthiness of a person or business. Banks typically look at both business credit ratings to make lending decisions and set interest rates. Every individual and every business has several credit scores, reported by various credit bureaus. The three major personal credit bureaus are Equifax, Experian, and TransUnion, and the major business credit bureaus are Equifax, Experian, and Dun & Bradstreet.
Each credit bureau calculates credit scores slightly differently, and it’s not always clear which lenders look at which scores. Generally, a credit score can be low for several reasons, including bankruptcy and late or missed payments to lenders, credit card issuers and suppliers. Some businesses are just too new to have a credit history.
“The most common reason [business owners get turned down for loans] in our community has no credit history or a low credit rating, ”says Ximena Arias, director of financial services at Mission Asset Fund. The San Francisco-based Mission Asset Fund facilitates loan circles – an interest-free peer-to-peer loan program – and reports loans to certain credit bureaus. This helps low-credit borrowers improve their credit rating and become eligible for traditional loans.
To increase their personal and professional credit scores, business owners need to make payments on time, spend well under their credit limit, and keep credit accounts open.
2. No guarantee
Banks often require collateral – physical assets that can secure a loan if it is not repaid – before agreeing to lend. However, new businesses may not have equipment or real estate to offer as collateral, or they may not be willing to use their personal assets (think: houses and cars) as collateral.
“The amount a bank will lend depends on the value of your assets,” says Stephen Sheinbaum, founder of Merchant Cash and Capital and Bizfi. “Houses and cars are the most common form of collateral, but if you don’t have anything the bank considers valuable, you will have a hard time getting a bank loan. “
Sheinbaum Companies are two online lenders that have emerged over the past decade to provide financing alternatives to bank loans. Merchant Cash and Capital provides cash advances to online merchants, and Bizfi is an online marketplace for small business finance options. Online lenders typically offer loans at higher interest rates than traditional bank loans, but often don’t require collateral.
3. Low cash flow
Banks want to make sure businesses have enough cash to make monthly loan payments, in addition to covering rent, payroll, inventory, and other costs. However, many small businesses struggle to keep enough money in the bank even if they are profitable, often because they have to prepay third-party vendors before being paid for their product or service.
Business owners need to understand how much money is flowing in their operations. If more money comes out than it comes in, they have to make changes.
“If your business has too tight a margin, try cutting expenses or finding ways to increase your income before you apply for a loan,” says Jay DesMarteau, head of small business banking at TD Bank.
While cash flow is still a challenge for many small businesses, it is improving for some. Fifty-eight percent of the 601 small businesses surveyed in April 2015 for Wells Fargo / Gallup Small Business Index report their cash flow has been “very good” or “somewhat good” in the past 12 months, compared to 50% last year.
4. Lack of preparation
“A lot of companies just don’t know the application process and think they can walk into a bank, complete an application and get a loan approved,” says Mark Palmer, managing director and analyst at BTIG, a global trading, brokerage and investment firm.
Before applying for a bank loan, businesses should have a written business plan, financial statements or projections, personal and business credit reports, tax returns, and bank statements, depending on the US Small Business Administration website. They should also have copies of relevant legal documents, including articles of association, contracts, leases and all licenses and permits necessary to operate.
5. Look for small loans
Most small businesses apply for loans under $ 100,000, according to a Harvard Business School Working Paper 2014 by Karen Mills, former administrator of the SBA. However, the banks want to take out larger loans because it is more profitable for them. It costs a bank about the same amount to process a $ 50,000 loan as a $ 1 million loan, but they can make more money by taking out the latter.
So while it can be difficult to get a bank loan as a small business owner, online lenders such as OnDeck, Lending Club, and Dealstruck have emerged to offer small dollar loans that traditional banks are unwilling to underwrite. The SBA also guarantees microloans up to $ 50,000.
6. Risk-averse banks
Lending to a small business is risky for banks. Since the 2008 financial crisis, many banks have raised their lending standards to avoid taking such a risk.
“After the recession, banks became more risk averse and unfortunately small business loans are inherently riskier than large business loans or even consumer loans,” says Rhea Aguinaldo, head of entrepreneurship. for the Small Business Majority, a national small business advocacy group. .
Some small business owners are more likely to obtain loans from community banks, where they have relationships with bank staff.
“Small businesses tend to perform better if they are known to the banker,” says Palmer of BTIG.