By: Matthew Gillman –
Many small business owners have experienced, or are continuing to experience, the harsh impact of the COVID-19 pandemic. In navigating through this tough time, many company owners have sought to apply for financing to keep their doors open.
That said, small business owners are not always seen as the most desirable loan candidates in the eyes of lenders. In fact, the latest Small Business Credit Survey published by the Federal Reserve Banks revealed that the approval rates for small business loans, credit lines, and merchant cash advances all declined after the onset of the pandemic.
Prior to March 2020, 61% of loan applicants were fully approved of the loan they were applying for, 20% were partially approved, and 19% were denied. When the pandemic started, only 44% of applicants were fully approved, while 26% were partially approved. The remaining 30% of borrowers got rejected.
If your application for small business financing was rejected, there could be a number of reasons as to why. In this article, we’ll provide insight into the most common reasons borrowers are denied a loan so you can be proactive in your preparation. Click To Tweet
Most common reasons for denied small business financing
If you were denied for a small business loan, it’s imperative that you identify the reason why before you re-apply. Here are some of the most common reasons applicants are denied:
1. You have a poor credit rating
Your personal and business credit scores are crucial in any type of small business financing you apply for. That’s because your credit score is a reflection of your ability to repay your debts or stay on top of monthly recurring bills.
The NSBA Small Business Access to Capital study found that 20% of small business loans have been denied due to poor business credit. Here’s a more alarming finding – a 2015 Nav American Dream Gap survey found that 45% of small business owners didn’t even know they had a business credit score, and 72% did not know where to find information about it. A whopping 82% did not know how to interpret their credit rating.
Having a poor credit score indicates that you’ve been missing your payment due dates, or that you’re not in good financial standing with your vendors. If you think your credit rating may be the reason for your denied loan application, you should revisit your FICO score and see which contributing factor you can improve.
2. Your business’ industry is too risky
As unfair as it sounds, many business loan applicants are rejected due to the nature of their business. Particularly during the pandemic, some industries have been more gravely affected by this than others.
The S&P Market Intelligence concluded that the five industries most affected by the pandemic are: airlines, oil and gas drilling, restaurants, auto parts and equipment, and leisure facilities. If your business happens to operate in any of these industries, it could be the reason why you were rejected.
Generally, small businesses are a risky investment to traditional lenders like banks and credit unions simply because of the nature of their business. If you believe that this is a disadvantage on your end, you can compensate for it by having high credit scores or showing your long-term business plan.
3. You don’t have enough time in business
In the eyes of traditional lenders, new businesses typically haven’t been in operation long enough to build up a solid business credit history that proves their creditworthiness. Businesses need to have a proven track record of their consistent bill payments for at least three to five years before they are granted a loan.
If your business is relatively new, you can increase your chances of being approved by using your personal credit as proof of your creditworthiness. You can also put up collateral to reduce the lender’s risk.
Small businesses that have not been operating for at least three years often get rejected by traditional lenders. If that is the case for you, you might want to consider getting alternative financing that won’t require a minimum number of years in business.
4. Your debt utilization is either too low or too high
You may think having zero debts makes you a more qualified loan candidate, but some lenders will actually want to see you utilizing your credit. Why? If you have credit that’s been sitting for a long time untouched, your lender can’t see that you are capable of paying off a debt. You would also lack a healthy credit history to back your loan application.
That said, they don’t want to see that you’ve over-used your credit either, as this will flag you as a risker borrower. Maintaining a credit utilization ratio of around 30% is ideal. This means if you have a business credit card with a limit of $100,000, you should try to keep your usage at around $30,000.
Always keep track of all your accounts and make sure your debt utilization is reasonable enough in the eyes of your lender.
5. You don’t have a solid business plan
Another common reason small business owners get rejected for a loan is because they don’t have a solid business plan. As mentioned, small businesses are generally riskier loan applicants than their larger counterparts because of their instability of income and lack of available resources to support growth.
A solid business plan can help you to assure your lender you are able to repay your loan until its maturity date. You can also show that your business has a clear growth direction, giving lenders the confidence that you won’t go bankrupt before you’ve completed your loan payments.
You’ll also need to present your cash flow statement to show lenders how much money is flowing through your operations. Some small companies struggle to balance their money even though they’re profitable because they have been paying their suppliers upfront, even before they receive their customers’ payments.
How to get approved for financing
Even if your loan application got rejected, don’t lose hope. You can still re-apply for financing, either with the same lender or a new one. To get approved for a small business loan, build your personal and business credit rating. Your minimum credit scores must be 600 for personal and 75 for business.
You should also find a lender who specializes in your industry and keep your debt utilization at a desired level. Don’t close your accounts even when you’re not using them as doing so will affect your credit score.
It can be devastating to be denied a loan, especially when you need the funds ASAP. Review your documents and coordinate with your lender so you know how to increase your chances of getting small business loan approval next time around.
About the Author: Matthew Gillman is a business financing expert with more than a decade of experience in commercial lending. He is the founder and CEO of SMB Compass, a specialty finance company providing education and financing options for business owners.