A small business loan from a bank or the Small Business Administration (SBA) is often the first thought of many businesses getting started or just looking for extra cash to buy equipment, stock shelves, and grow operations. However, things don’t always go to plan, and many companies receive business loan rejections.
While the rejection letter may sting, there’s plenty your business can do to get its hands on the funding it needs.
Reasons Why Business Loans Get Denied
You may wonder what went wrong if you’ve recently been denied a business loan. Understanding common business loan rejection reasons is the first measure you should take to strengthen future applications. Lenders consider many factors while evaluating loan requests, so it’s essential to be aware of each to successfully acquire the funds you need.
Discover seven of the most common SBA loan denial reasons.
1. Poor Credit
Credit scores are vital signifiers that lenders use to realize the level of risk associated with a borrower. Financial institutions often look at personal and business credit during an application evaluation unless a company is relatively new. In that case, they will assess only your personal credit score. Most borrowers should strive for a score of 680 or higher. This number can decrease due to defaults, bankruptcy or late payments and likely cause your small business loan to be denied.
However, many lenders will still work with businesses with lower scores. If you do find an institution that will provide a loan, you may have to follow certain requirements and pay a higher interest rate.
2. Lack of Experience
Many banks will only work with organizations that meet their business history stipulations, requiring them to have operated for anywhere from six months to two years or more. This factor will complicate your application if you are a new business or planning on building one from the ground floor, as lenders will likely deny your application.
Conducting a thorough search of financial institutions offering small business loans is wise. Qualifications will often vary with each lender, and some may come with less strict requirements. It can be prudent to find another loan that is easier to obtain or simply wait for time to pass if you can.
3. Cash Flow Problems
You may be asked to display your monthly or annual revenue during the application process. Lenders require this number to see if you have an adequate flow of capital into your company to cover operating expenses with the addition of current or future loan payments.
Some institutions require minimum amounts to qualify, which could range from $100,000 to $250,000. They will deny your application if your current cash flow doesn’t fall within that scale or if you can’t show the necessary documentation. It’s helpful to observe your weekly cash flow to generate reports and projections to put yourself in the best position to be accepted.
How To Use the Cash Flow Margin Calculator
Fill in net income.
Fill in depreciation and amortization.
Fill in the increase in net working capital.
Fill in sales revenue amount.
Enter values above and click Calculate.
4. Insufficient Collateral
With any kind of loan, a lender takes on some degree of risk. It’s common for banks to mitigate that risk by requiring their borrowers to secure their loan with their business assets that have proven value. This collateral enables them to recoup the loan’s outstanding balance by seizing the asset if a borrower defaults. Businesses without sufficient or valuable assets, or assets that have already been pledged elsewhere, may receive a denied loan application.
Of course, you could search for a lender offering unsecured loans. However, these options have higher interest rates and fees to offset the risk.
5. Failure to Provide Required Documentation
Having the right financial documents is an essential component of any business loan. While some lenders maintain straightforward loan applications with only the key paperwork, others are more intricate, with extensive financial documentation. Not submitting the required information can delay the entire process and lead to a rejected application.
Some of the most common documents your business will need include:
Personal and business bank statements
Personal and business tax returns
Profit and loss statements
A business license
Articles of Incorporation
A business plan
6. Carrying Too Much Debt
Consistent and intelligent use of credit is essential to successfully receiving a bank loan, demonstrating that your business poses minimal risks. However, lenders will likely reject business loan applications for companies with too much debt. Banks place a significant emphasis on your business’ credit utilization rate, which is the amount of credit you currently use out of your total limit. Organizations with ratios above 30% are generally denied business loans and viewed as riskier investments for lenders.
7. Operating in a Risky Industry
Some industries are inherently riskier than others, which lenders tend to avoid. While some lenders specialize in riskier professions, industries like restaurants, agriculture and construction generally have a track record of being denied business loans. This business loan rejection stems from increased risk perception due to unstable revenue and elevated failure rates.
Regardless of your qualifications, documentation, credit score or suitable cash flow, doing business in a risky industry could be the reason for your SBA loan denial.
Steps to Take If You Were Denied a Business Loan
After your business loan is denied, you may wonder where to go next. Luckily, you can take an assortment of actions to enhance your company and obtain the funds you need.
Pinpoint the Reasons You Were Denied
As you read above, there could be a handful of reasons for your business loan rejection. Newer businesses are often passed over for their lack of experience, low credit score, poor cash flow or inadequate documentation.
Before anything else, you should discover why your lender denied your request for a business loan. This valuable information will help you make meaningful changes for the future, giving you a better chance at approval when reapplying.
To better understand their reasoning, ask your lender to explain the decision to you. Most institutions are more than happy to explain their requirements and thought processes to help you obtain funding down the line.
Find Ways to Improve Your Credit and Finances
Once you understand what you need to improve upon, you can start enacting change throughout your operations. Since credit is an essential factor, it is often an excellent place to start. There are plenty of ways to boost your score, such as managing the debt you’ve gathered and making regular, on-time payments. There’s no need to pay off the entire sum, but consistent payments will show your reliability in repaying loans and keeping your revolving utilization low.
Used by many lenders during application evaluations, the debt service coverage ratio (DSCR) is a valuable tool to use to strengthen your overall finances. It compares your business’s level of cash flow to your overall debt. This tool will help you understand if you’re generating enough income to afford a loan. Knowing this information, you can look for ways to increase revenue, acquire more valuable business assets and reduce expenses and debt. Even the smallest alterations can send your business in the right direction.
Consider Alternative Lending Providers
If you can’t wait 90 days to reapply or want to avoid another extensive process, you can find an alternative method to secure the funding you need. Instead of going through a traditional institution, you can seek out nonbank lenders offering beneficial loan agreements with flexible terms and relaxed requirements. These establishments are available in the form of direct online lenders, private lenders and marketplace lenders.
Some of the funding options you can obtain include:
It may be worth waiting and applying in a few months for businesses and entrepreneurs that don’t need an influx of cash right away. Waiting may seem like you’re doing nothing, but in reality, you’re building up your experience and proof that you can repay a loan.
Most newer businesses have been denied business loans due to a lack of history. By taking time to establish your business, generate profits and follow your business plan, you’ll create a log of financial successes that a lender is less likely to turn down.
Ideal Credit Score to Get a Business Loan
There’s no specific credit score that will secure you a loan automatically. However, most lenders place significant weight on your personal and business credit scores when making decisions regarding your business loan. These scores also help lenders determine some of the terms of your loan, including loan amount, annual percentage rate (APR) and repayment schedules.
Minimum credit scores vary from lender to lender. You can generally expect loans from alternative institutions to range anywhere between credit scores of 500 to 600. These options may come with higher interest rates and more extensive collateral. For traditional business and SBA loans, you should strive to have a credit score of at least 640 to be considered, although it’s often better to have a score of 680, if not in the low 700s. Of course, the higher your score, the more likely a lender will be to trust you with a loan.
Fund Your Business With Porter Capital
If you’re struggling to acquire the funding you need after being denied a small business loan, Porter Capital is ready to assist. With 30 years of experience, we can help you obtain the funds you need with our invoice factoring services, providing you with access to your capital in less than 24 hours without the cost and strict qualification of traditional loans.