For every successful business, there comes a point when personal financing is no longer enough to sustain the growth of the company. Whether they need to purchase larger, more advanced equipment to meet production demand, buy more inventory or more property to expand operations, or hire more staff, most businesses will be left with no choice but to reach out to a bank for a business loan eventually.
Unfortunately, many loan requests will get rejected, especially if the request comes from SMBs (Small and Midsize Businesses), also known as SMEs (Small and Medium-sized Enterprises).
It is increasingly difficult for SMBs to get loans through traditional methods such as banks (most banks in the US, for example, won’t give out loans below $100,000), which raises the stakes even higher for everyone competing to secure a bank loan. By understanding the main reasons why banks reject loan requests, you can get a leg-up on the competition and ensure that you take the appropriate measures to protect yourself before making an application.
These are the top five reasons why banks will reject a loan request:
What Is Your Credit Score/History?
When banks loan money to businesses, the number one thing that concerns them is whether they will be able to get their money back. Your credit score, which represents your company's financial history, is the most useful indicator in verifying that you're a trustworthy business that can pay back its debts. Banks want to ensure that you have a long-established record of paying back your debts on time (most banks require a transaction history of a minimum of two years) before they will approve a loan.
If your business has a bad credit history due to poor cash management and not paying back debts, then the bank is not likely to trust your ability to pay back your loan and will, therefore, reject your loan application.
Bonus Tip: One of the best things you can do to build good credit is to always pay your bills on time, or even better, early.
Another reason you might get rejected for a bank loan is if you can't provide either sufficient collateral or the specific type that the lender requires.
Collateral is an essential component to the approval of loans because it protects lenders if the borrower cannot repay their debt by giving them something of equal value to the amount borrowed. This typically includes big-ticket assets, such as property and factory equipment. At the same time, it acts as an incentive for the borrower to pay back their loan, so they won’t risk losing their assets.
Bonus Tip: Small businesses which do not have anything to offer as collateral have the option of an unsecured loan. This is a loan without the requirement of collateral, which means that if you cannot pay off your debt, the lender can't take possession of your assets.
Evidence of Inconsistent Cash Flow
As we mentioned earlier, banks want to ensure that you have a steady enough cash flow to pay back your loan before lending you money.
You must be able to comfortably cover both your business expenses and loan payments and have some extra cushion in the case of any unexpected expenses that could lead to you falling behind on your repayments.
Good cash flow does not only represent your ability to pay back your loan; it also represents the strength of your business. Many companies that declare bankruptcy do so because of cash flow issues. Therefore, if you earn just enough profit to cover your daily operations and loan payments—without a cushion for unexpected expenses—you are still considered to be a high-risk client, and banks are not likely to approve your loan.
Reasons for poor cash flow include:
- Being part of an industry with seasonal fluctuations
- Poor cash management that leads to overall limited cashflow
- Major drops in finances
- For lenders, only a steady and reliable cash flow shows that you have longevity as a business, which makes them more willing to lend you money.
Bonus Tip: If your business is seasonal, make sure to offer another product or service that will supplement your cash flow during the low-season months. Alternatively, change your payment policies by adding late penalties or shortening the pay period to ensure a more consistent cash flow.
In addition to irregular cash flow, banks will also consider you as a high-risk debtor if most of your income comes from a concentrated source. That means that banks aren’t likely to loan to businesses that are reliant on one group of customers to keep them afloat, even if they have good credit and cash flow. Because if that group of customers ever goes away, that business's entire source of income is immediately gone - and with it, their ability to pay back their loan!
Therefore, despite customer loyalty being highly valuable to a business, it is just as important to have variety in your clientele. Diversity will ensure that you are protected should you ever lose that business relationship with your core group of customers. A broad consumer base will guarantee that if this ever happens, you have a large enough income source to keep your business running successfully.
Bonus Tip: Get the word out about your business. Put active effort into your marketing and advertising strategies which are crucial to expanding your brand awareness and therefore your base of clientele, thus improving your chances for loan approval.
A Weak Management Team
A business, even a small one, needs a strong management team. After all, they’re the ones with the education and experience required to help your business grow. It is their job to come up with and execute the strategies that will make your business grow successfully.
That is why the management team's strength is at the top of the bank's list of requirements to get a loan approved. For them, the existence of a strong leadership team that displays effective and efficient decision-making is a guarantee that they will get their money back.
If you’ve had a loan request rejected, try working on all the above to improve your prospects in the future, not only for obtaining loans but for the success of your company in the long term.