For roughly 80% of business owners, getting denied for a bank loan is a shared frustration.
We’re here to help you understand the most common reasons (both quantitative and qualitative) a bank will deny your business loan, so you can make changes before applying for the funding you need.
We’ll also provide some alternatives many businesses owners can consider today to bridge the gap as many small businesses cannot afford or be able to make these changes overnight.
1. Poor Credit
Virtually all lenders will consider your personal and/or business credit score when you apply for a business loan. Banks examine these even more closely than would alternative lenders that typically have less stringent requirements.
At any point in time before you opened your business, you most likely had incurred some form of personal debt or expense (such as a car payment, mortgage payment, or a utility bill), and indicators of your creditworthiness such as your payment history can be seen in your personal credit. Not to mention that many business owners used their personal credit cards to fund their business when starting up. This is why your personal credit score matters and as a general rule of thumb, you should strive to have at least a 650-680 FICO Score or preferably 720+ in case of a recession (as this is usually when banks tighten their guidelines and thus make it more difficult to qualify to protect their own interests)
Business credit is also important to help you gain favorable rates when working with vendors and suppliers. In other words, when you’re looking to grow your business but lack the funds, building business credit becomes essential to your business’ creditworthiness and a bank’s assessment. For example, you don’t want to have a bad rep such as civil judgments (unpaid debts taken to court) popping up and hurting your chances of getting approved.
Simple ways to build business credit are utilizing business credit cards, vendor accounts, and separating your business and personal bank accounts.
2. Insufficient Debt-to-Income Ratio
Commonly referred to as Debt-Servce-Coverage-Ratio (DSCR), DSCR is a metric used to compare a business’s level of cash flow versus its debt obligations.
This can be calculated by dividing the business’s annual net operating income (NOI) by the business’s annual debt payments. See below:
Debt Service Coverage Ratio (DSCR) = Business’s Annual Net Operating Income / Business’s Annual Debt Payments
To figure out your annual net operating income, most lenders use EBITDA (Earning before interest, taxes, depreciation, and amortization), which is considered the equivalent of your Net Operating Income (NOI) here. Take your business’s annual net income (annual revenue minus all expenses) and ADD back taxes, interest, depreciation, and amortization.
Let’s say your business’ NOI was $150,000 per year and the total debt payments is $100,000 per year. In this case, the DSCR would simply be $150,000 / $100,000, which equals to 1.50, which means that the NOI covers the debt service 1.5 times.
A DSCR greater than 1.0 means there is sufficient cash flow to service the debt, and as a general rule of thumb you shouldn’t apply unless you have DSCR of AT LEAST 1.0 but preferably 1.20 or higher.
Do not automatically assume that having a DSCR of 1.0 means you will get approved, as banks want you to have a cushion to service their debt payments in case of unforeseen circumstances or to weather through slowdowns.
3. Insufficient Collateral
For small businesses that can’t afford to pledge assets (such as equipment, real estate, or other big ticket assets) or simply don’t have any, will often run into a wall even under circumstances of being pre-qualified on credit and cash flow.
In short, your loan can be denied by not having enough collateral or having any type of collateral the lender wants to secure the loan with.
If you’re gunning for a bank term loan or commercial real estate loan (most common and desired bank loan options) then you better be prepared to risk your business assets and if that’s not enough, your personal assets as well.
Not to worry though, as there are plenty of alternatives available such as unsecured business loans or lines of credit that don’t require collateral.
4. Inconsistent Cash Flow or Declining Revenue Trends
If your cash flow is inconsistent, or worse such as declining year-over-year, then how will you pay back the loan?
The reason banks seem to request a financial colonoscopy (mounds of paperwork) is to make sure you have a proven track record and are able to make the loan payments.
In short, banks are not willing to risk their money on a sinking ship or speculative pies in the sky.
5. Not enough time in business
Getting a small business loan when just starting up can be tricky. After all, you need working capital to pretty much do anything, but haven’t proven that your business model will last.
In short, if you’ve been in business for less than 2 years, then you shouldn’t expect to get a traditional bank loan. Most banks will require at least 2 years of business and personal tax returns when you apply, which means you may even need to be in business longer.
There are roughly 200,000 new businesses every month in America and 180,000 that close its doors. In year one, about 80% of businesses survive. By year five, it’s less than 50%. By year ten, only one out of three are still open.
If you plan on only trying to get a bank loan, you may find yourself in a catch-22 situation. The bank requires that you have a long enough credit history with a proven track record of paying on time and meeting your financial obligations. However, you may need a loan or credit card to even start building your credit.
6. Industry Concerns
If you’re in an industry with a high rate of failure, then even having a solid business plan may not be enough.
Certain industries like restaurants often find it difficult to qualify for a bank loan for this reason.
Other industries can become affected from regulations that make it more difficult or expensive to operate in. In other words, it increases the risk that a bank will have to take. Rather than take on that risk, banks often will look to other industries or tighten their qualification requirements, making it even less accessible to most business owners.
Though you can’t change your industry, you can look for lenders that specialize in your industry or shop through a reputable marketplace that have all options available for you to compare.
7. Customer Distribution
In short, this is the danger of putting all your eggs in one basket. If your revenue comes from that one whale of a client, what happens if you lose that client?
Things banks can look at include how much of your revenue comes from a select number of consumers, businesses, or governments. If you’re doing business with larger or reputable companies such as Costco as opposed to shady Sam next door, this looks better because more often than not bigger companies pay their bills on time. Also, customer loyalty is without a doubt positive, but the point here is to minimize risk by having a diverse portfolio of customers.
In short, work on expanding your client base now to mitigate the bank’s concerns and for your own financial security.
8. General Economic Concerns
By now you should’ve realized that banks are more concerned with their own interests. If current economic conditions are unfavorable, then the risk of a bank not getting its money back on time becomes even more concerning. To mitigate this risk, a bank will typically make it more difficult to qualify, leaving even more business owners with the burden of getting through difficult times on their own.
9. Insufficient management team
Banks are known to reject small businesses that lack a strong top-level leadership or chain of command. In other words, banks may lose confidence when assessing the long-term success of your business if you lack the organizational integrity and experience expected to succeed.
10. Incomplete Paperwork
Given that business owners can spend an average of 20-30 hours on a bank loan application, it’s not uncommon to make mistakes or not even have the supporting documentation that may be requested later in the application process.
Banks will often require a business plan, 3 years business and personal tax returns, business bank statements, financials and/or projections, and credit reports just to apply. Later on, they may also request legal documents related to your business such as leases, contracts, licenses, permits, and corporate documents.
Today, there are smarter ways to compare bank loan options through one application and with expert guidance along the way.
Bridge the Gap Today with Alternative Financing
So, what can you do if a bank declines your small business loan application?
The good news is there are plenty of alternative funding options to fill the void left by the banks. The surge of fintech companies has created flexible terms for business owners who need fast access to capital to grow their business.
So whether you have less than perfect credit, been in business for less than 2 years, or in an industry banks don’t want to touch, here are some options you can qualify for today.
- Business Line of Credit and Credit Cards
A line of credit and credit card is a great way to build your credit and to get ongoing access to a pool of funds to cover day-to-day expenses.
In short, it is a great way to cushion your cash flows and get peace of mind.
- Merchant Cash Advance
The lender essentially purchases a set amount of your future credit/debit card sales to provide you with working capital today.
Rather than making fixed monthly payments, an MCA will automatically deduct a small percentage from your credit/debit card sales until the cash advance is repaid in full.
Some lenders also offer pre-payment discounts so you can save on the cost be repaying early.
- Business Loans
These non-traditional business loans usually are either short-term or long-term. For short-term loans you will have to repay the loan with interest in generally under 2 years. For longer-term loans, they can go up to 5 years, which means a lower payment but more time to accrue interest.
These loans generally go up to $500,000 and can be used to cover virtually any business need.
- Equipment Financing
Getting the right equipment, appliances, software, tools, and vehicles can mean all the difference in growing your business efficiently.
One of the great things about equipment financing is that you don’t have to have a great credit score to qualify, since the lender can collateralize the equipment you are looking to buy.
- Accounts Receivable Financing (Invoice Financing)
This option can turn those unpaid invoices into cash, so you don’t have to deal with a cash flow crunch by waiting for your debtors to pay. The important thing here to note is that lenders care more about the creditworthiness of your debtors rather than you.
So if you’ve got outstanding invoices from big brands like Costco, then this would be a great consideration.
Don’t stress if you’ve been rejected for a bank loan. Instead, apply through a transparent marketplace like Liquidus Funding to compare all your business loan options with or without a bank and through one simple 15-minute application.
Even if you’re not ready to make a move, its better to plan ahead by knowing your available options today and get a roadmap on improving your options for tomorrow.
This way, you can make smarter financial decisions for your business and avoid waiting until the last minute to settle for costlier options.