Starting your own business can be very rewarding. If you get into an industry you are passionate about, you could be earning from doing what you love. Apart from getting a sense of fulfillment, there are other benefits. You get to dictate your own work schedule, and pick your co-workers.
Recruiting the perfect team can boost your morale, and help create a conducive working environment. However, more goes into running a business than managing human resources. You need to think about finances, marketing, sales, accounting, and customer service.
All the activities involved in a business are vital, and you need to pay attention to each one for your business to succeed. According to research, 20% of new businesses fail within the first two years, and only 25% of new ones make it to 15 years.
One of the reasons behind such low success rates is financing problems. As you begin your business, you need to acquire enough capital to get your business through the first six months. After this period, you will be eligible for a loan. At this point, most small ventures urgently require loans for working capital.
Small business loans can be a win-win situation for businesses and lenders. After all, both sides have their interests at stake. The lender wants to see that their money is well invested, meaning you can repay your loan and interest. On the other hand, the business needs financing to grow and expand.
However, securing a small business loan is not always as simple as it sounds. There are numerous reasons lenders deny loan requests. However, not all the reasons affect the long-term viability of a loan.
Once you know what causes most rejections for small businesses, you can work on improving your creditworthiness. Doing your due diligence increases your chances of getting a loan in the future. Below are common reasons why a lender may deny your business a loan.
1. You Have No Track Record
If you’ve applied for financing before and haven’t gotten approved, it might be because the lenders are looking at your track record. That means they’re looking at the information available on your previous business dealings.
If you have no track record, that means you have no references. A lack of references gives lenders a hard time deciding whether to give you a loan. You can get around this issue in several ways.
One is to start a new business under a different name. That way, you have a new track record and separate credit history. Another option is to use a business name that you already own. Examples include your name or the name of your company. That way, the lenders will see that you have a track record with previous ventures under that name.
2. There Are Other Loans Against Your Company
Sometimes you may require a working capital loan to keep your business running. Businesses may also have to endure a period of slow cash flow, so you may need a loan. Lenders check to see whether you have any loans against your company.
Make sure to you pay off other loans, and the interest they have accrued. Otherwise, lenders may think that you are not credit-worthy and reject your application.
Hiding past-due debts is difficult, especially if the creditors are willing to take legal action against you. The best option is to pay off old debts, and bring all your payments to a current status. This can reduce the loan against your business name, and improve your credit score.
3. You Have Bad Credit
Lenders will look at your credit score before offering you a loan. Your credit score is a number that can indicate how creditworthy you are. The score is based on past financial transactions. Small businesses working capital loans usually need a score of about 650. Anything below that will make securing a loan difficult.
In most cases, the best way to get a better credit score is to pay off any outstanding debts, and improve your payment history. There are ways to improve your credit score without taking on additional debt.
One option is to get a credit card with a low monthly limit. Make small payments on that card each month, and improve your payment history. If you cannot fix your credit score quick enough, you can look for bad credit lenders.
The good thing about bad credit lenders is that they are willing to give loans for working capital. However, you will secure the loan at a high-interest rate. This can make loan repayment difficult.
4. Collateral Issues
Collateral is an object given to a lender as security for a loan. Lenders often require that you put up some collateral. Collateral helps to ensure you repay the loan, and pay off the original amount.
If the lender is concerned that you might not be able to repay the loan, they may ask for collateral. You may have to use personal assets if your business has none. This could include putting up your home, car, or any other resource to guarantee that you repay the loan.
If a lender is asking for collateral, it is often not a good sign. You can also try to work with the lender to generate a payment plan that works for all parties. If you can demonstrate that you have a plan for repaying the loan, the lender may be less likely to require collateral.
5. Your Business’s Debt to Asset Ratio Is Too High
Another factor that lenders look at when deciding whether to loan you money is your debt-to-asset ratio. This ratio shows how much of your income is going towards repaying debts verses the amount going back to your business.
In most cases, your loan request won’t go through if your current debt-to-asset ratio is too high. The debt-to-asset ratio is calculated by dividing your total assets by your total liabilities.
6. You Don’t Meet Requirements
Lenders will often ask you to provide more information to support your application for a small business loan. For example, they may ask to see more financial documents, such as bank statements and tax returns.
They may ask you to provide more details about your business. The documentation may include an official business plan, or a copy of the contract your contract workers sign.
If any of these documents fail to meet the minimum requirements for your loan application, the lenders will likely reject your application.
7. You’re in an Incongruent Industry or Business Model
It’s important to remember that lenders consider many factors when deciding whether to approve a small business loan. One of the most crucial factors is your creditworthiness.
Lenders may also check to see if your business model is viable and consistent with the industry that you are in. For example, lenders are especially cautious if you’re in a highly competitive industry, like technology or healthcare.
This is because you need to have a proven track record of success. Creditors also want to see that your business model is sustainable. Apart from highly competitive industries, creditors may be weary of crediting businesses targeting new markets.
A lender is less likely to loan to you if they do not understand your field, or if it is new. In this case, creditors won’t have much information to help them make their decision. Therefore, they may be unwilling to risk financing your business.
8. The Loan Amount Is Too Small
One of the most common reasons why a small business loan is rejected is that the loan amount is too small. While it is good to work with your lender to generate a plan to pay off the loan within a reasonable period, the loan amount should be reasonable.
Most small loans are also not worth the trouble for the lender. The process involved for a large loan is similar to that of a small amount.They cost the lender the same amount of time and resources.
However, one has a lower return on investment. A lender therefore usually avoids giving small loans because they are not as profitable.
9. The Loan Amount to Value Ratio Is Too High
The final reason that may cause a loan application to be rejected is that the loan-to-value ratio is too high. The loan-to-value (LVR) ratio shows how many of your assets are being put toward the loan.
Aim for an LVR of below 80%. That will be good enough for most creditors. The lenders will most likely reject your application if this ratio is beyond that. They may think that it is a high-risk business venture.
It is possible to find lenders willing to loan to you, even with a high LVR. However, these loans usually have a high-interest rate.
Running a business can be a struggle. However, you can get a loan to help you through the rough times. There are online and physical creditors that are ready to give your business a loan.
Despite the positives of taking out a small business loan, you also need to prepare for the worst-case scenarios. Consider the factors above to increase your chances of getting approved for a small business loan.