The Real Reason Banks Deny Loans to Many Small-Business Owners

Small business owners face many challenges when trying to grow a business. Although there are various options for financing small businesses, it’s becoming harder to find capital. New businesses are the riskiest loans that banks or lenders encounter therefore owners are struggling getting small business loans, bank financing, and they suffer from rejection.

With the struggle small businesses are facing, owners have considered shutting down due to lack of cash flow. They apply and are turned down, sometimes even rejected more than once and don’t know the exact reason why which can be frustrating. This leads to owners using personal funds to keep their businesses going. Other ways owners are getting money are by using credit cards and by family or friends.

The primary reason small businesses can’t get loans

Small businesses can’t obtain loans due to not understanding their business credit score. Owners either don’t know they have a credit score or where to find the information about it. A business credit score can be the main deciding factor whether you get financing or not. Some even have poor scores without even realizing it due to maxing out personal credit cards which can harm the ability of receiving financing.

Lenders are not required to explain or notify the owner of why they were rejected. It’s important for a business owner to make timely payments and boost their credit score up to have a good score. This needs to be done before any credit application is submitted. This will put the company in better position to receive the needed funds.

Other existing factors

While poor credit is the main reason small business can’t get loans, being a new business is also another reason.  New businesses typically will not have any credit history so personal credit will be considered in detail. If your credit report has one negative rating, you will be rejected. Also, low credit ratings will be affected in your chance of getting funding so if you have low scores you need to work to raise it. In the end it will require high assets of security or you will be rejected.

If your business is in a high-risk industry, your application will not be approved, regardless of how good your financial standing or history is. For example, lenders see sole proprietors as high-risk because there’s a high chance the loan cannot be repaid due to lack of income. An industries risk is rated by Standard Industrial Classification (SIC) codes. Each startup and small business owner should be aware of their four-digit SIC code. If this is your case, you can look for other lenders that specialize in your specific industry.

Lack of cash flow is a red flag because of the fear that businesses will focus on paying their expenses rather than paying off a loan. Your business income needs to cover your current finances plus the loan payment. Lenders want to know you have a strong cash flow, so you don’t miss any payments. Cash flow issues include enough overall, dips in cash flow, or seasonal fluctuations.

If your business has insufficient collateral, this also shows a red flag. Lenders prefer to work with those who have collateral in case the business defaults on a loan. They want to have equipment, real estate or other valuable items to secure a loan.

If you lack experience, you will also have difficulty getting approved. When you have experience in the industry, it means you know what to expect and are aware of any financial problems that may arise. At least one year of experience working the profession is required.

Other ways to get money for business startup

If any of the above reasons apply to you, you shouldn’t give up because there are other ways to get funding for your small business.

  • SBA loan guarantees: the SBA 7(a) loan program is a good place to start. This will give guarantees to lenders and is more time consuming, but it is worth it to get your funds.
  • Family and friends: you can also ask family and friends to help you with startup funds.
  • Trade credit/vendor financing: if you buy equipment, inventory, materials or products from a vender, ask them for longer terms or setting up credit accounts. This will also help improve your business credit rating.
  • Merchant cash advances: with this program you get capital by purchasing a set amount of your future debit/credit card sales.
  • Seller financing: you can pay the seller back from your profits if you are buying a business while guaranteeing part of the loan.
  • Credit card financing: you may also consider credit card financing but beware of this option because of the high interest rates and if your sales don’t take off you could be in financial trouble.

No matter how prepared you may be when applying for a loan, you could come to find that your application has been denied. Fortunately, there are other options to consider if this is the case for your small business. Owners should determine where they stand and take actions necessary to improve their chance of getting approved if possible.