Applying for loans is the best way small businesses can get cash influx. Business loans can be used to steer financial growth, make large purchases, and cover daily operational costs, and other business activities. Unfortunately, while business loans are beneficial in many ways, small businesses rarely get approval.
Most lenders and financial institutions have rigid approval requirements for business loans that few businesses only qualify for. This is true, especially if you need funding from banks and other traditional lenders. Banks impose rigorous requirements that only 28% of small business requests were approved in 2019.
Small businesses looking for funding should prepare adequately for these roadblocks. Below are the common reasons why your small business loan can be rejected.
1. Bad or No Credit History
Most lenders rely on credit scores when evaluating loan applications. Typically, the credit score demonstrates the borrower’s creditworthiness and risk level to lenders. Unfortunately, lenders scrutinize personal (entrepreneurs) and business credit scores when reviewing loan applications.
New businesses without financial statements often rely on the business owner’s credit score. Ideally, borrowers should have a FICO credit score of 680 and above to be approved for small business loans. Your small business loan may be rejected because of the various factors that damage your credit score.
As such, you should consider alternative forms of financing, such as ODSP Payday Loans or merchant cash advance and business credit cards. You can also reapply for conventional loans once you improve your credit score. Common causes of poor credit score include:
i). Late payments
35% of your credit score is determined by your individual or business payment history. Creditors often report to credit bureaus delayed or missed payments.
Similarly, if you have missed or delayed payments to lenders, utility providers, or credit card companies, this information is captured in your credit report, affecting your overall score.
ii). Collection accounts
If creditors cannot secure payments from borrowers, they hire third parties to enforce collection. Most lenders sell the delinquent debt or hire debt collection agencies to enforce collection.
All this information is captured in your credit history, making it hard for creditors to provide loans to borrowers with poor collection history.
An individual or a business may file for bankruptcy if they can’t pay debts. While filing for bankruptcy provides legal protection, it can damage your credit history.
Information about individuals or businesses that have been declared bankrupt is recorded in their credit history for seven years. Due to the complex nature of bankruptcy cases, most creditors prefer to avoid approving loans to borrowers with such a history.
iv). Charge-offs and defaulting on loans
If your business loan application was rejected due to poor credit, review your personal and business credit report, and identify areas that need improvement. This includes making payments on time, applying for multiple credit cards, and paying off credit card debt.
2. Lack of Strong Cash Flow
Cash flow is the other major factor that lenders use to determine loan approval for small businesses. Creditors often want to verify that the business has sufficient cash flow to make monthly payments and manage other expenses, such as rent, taxes, and employee payroll. Lenders flag businesses that have irregular or seasonal cash flows.
If your small business loan was rejected due to weak cash flow, you should look into your cash management skills. Some of the best ways to improve cash flow and up the chances of loan approval include:
i). Negotiate quick repayment terms
Small businesses should make sure their clients deliver payments timely after making sales. If your cash inflows (accounts receivables) accumulate because customers don’t pay in time, your business can experience a cash-flow shortage, even if it is profitable.
Besides negotiating payment terms with clients and having deadlines, you should also ask for partial upfront deposits and remind customers who are late on payments.
ii). Give clients incentives and penalties
You can also encourage customers to make early payments by offering discounts and penalties for late payments. For instance, you can offer them a 2 per cent discount on invoices cleared within seven days or discounts on future purchases.
iii). Revise the terms on your accounts payable
As you improve your cash inflows, you can also take an opposing strategy on your accounts payables or cash outflows.
Instead of paying your vendors immediately, read through their terms on the payment period or deadline for making payments. Delaying your payments can prevent a possible cash shortage. Don’t shy away from negotiating with vendors.
iv). Reduce unnecessary spending
Business expenses, such as costly phone plans and unsold inventory, can sneak up on your cash flow. While some purchases may cost a few dollars, they slowly add up and drain your cash flow.
3. A Weak Business Plan
Business loans can also be rejected because of a weak business plan, especially for new businesses.
Business plans typically provide formal explanations of the business goals and how the business intends to achieve them. While not all lenders ask for business plans during loan applications, it is a requirement for banks.
Lenders ask for business plans to evaluate how their money will be used. They use the plan to evaluate the feasibility of your growth strategies and whether the business activities are profitable.
If requested, make sure your business plan explains why you want the loan, how you intend to use the funds, and repayment plans. The business plan should include the requested loan amount and the following:
- Summary of the company.
- Profitability projections.
- Financial statements of the business, including cash flow statements, balance sheets, and expenses.
4. Incomplete Financial and Legal Documents
Most small business loan applications are streamlined with an easy application process. However, some lenders have complex application processes and extensive documentation.
Failing to support your loan application with all the required documents delays loan approval and can lead to complete rejection.
Fortunately, identifying missing documents shouldn’t be challenging, especially since most lenders often reach out to applicants during the review process. You should constantly check your email and phone for communications from lenders.
However, if the application was denied due to missing information, ensure you have compiled everything before reapplying. Some of the common documents required by lenders include:
- Business and personal bank statements.
- Business and personal tax returns.
- Business financial statements, specifically profit and loss statements.
- Business plan showing how the business generates profits.
- Legal documents, including articles of incorporation and business license.
5. Operating in a Risky Industry
Most small business lenders have tight regulations that guide the approval of small business loans for specific industries.
Regardless of the profit margin of your business, lenders won’t approve loan requests if they perceive your operation industry as unpredictable or risky. For instance, some lenders consider the construction industry a financially unstable realm due to the seasonal nature of the construction business.
Lenders can also consider external conditions when reviewing your loan application. For instance, a service restaurant loan application may be rejected due to rising food prices. High food prices make it difficult for business owners to make profits.
6. Many Applications
Most small business owners tend to apply for business loans from different lenders simultaneously. Most think that submitting many applications increases their chances of being approved.
However, submitting many applications can work against your business. Submitting many loan application forms affects your credit score and discourages creditors from loaning your business.
Small Business Loan Rejection Reasons to Know
Here are some reasons why your small business loan may be rejected:
- Bad or no credit history.
- Lack of strong cash flow.
- Incomplete financial and legal documents.
- Operating in a risky industry.
Failing to qualify for a business loan is a major setback for small businesses. However, it isn’t the end of potential success.
Small business owners should identify the reasons for loan rejection and take the necessary steps to improve their chances of approval. Similarly, choosing the right lender can increase your chances of being approved.
I am Adeyemi Adetilewa, a media consultant, entrepreneur, husband, and father. Founder and Editor-In-Chief of Ideas Plus Business Magazine, online business resources for entrepreneurs. I help brands share unique and impactful stories through the use of public relations, advertising, and online marketing. My work has been featured on the Huffington Post, Thrive Global, Addicted2Success, Hackernoon, The Good Men Project, and other publications.