Was Your Small Business Denied a Loan? Here’s What to Do

Getting denied for a loan as a small business is fairly common. According to the Private Capital Access Index (PCA Index) by Dun & Bradstreet and Pepperdine University, 47 percent of small business respondents found it difficult to acquire debt financing in the first quarter of 2019. But do not be discouraged. A rejection is simply a signal that changes need to be made to acquire financing down the road. Especially if this is your first time applying for financing, these tips to re-applying can help you be more successful in your next attempt.

Step 1: Find Out Why You Were Denied a Loan

Lenders are required by law to provide a reason in writing as to why you were denied for a loan. However, sometimes these reasons can be vague. Typically, there are five major reasons for a denial, commonly referred to as the “Five C’s of Credit.”

• Credit score: Both your personal and business credit scores will likely be taken into account when you apply for a loan. If your personal or business credit scores are too low or if you have red flags in your reports, such as a late payment or a bankruptcy, this could be a barrier to acquiring financing. The length of your credit history is also important. Banks generally like to see three years of personal credit and one year of business credit to evaluate your likelihood of repaying a loan.
• Character: Discrepancies with the business owner’s trustworthiness, such as a criminal record, could also be a red flag to lenders.
• Collateral: If your business does not have enough assets to secure your loan, you may be denied. This could include physical assets such as real estate and equipment or working capital assets such as inventory and accounts receivable. If you are personally guaranteeing the loan, your personal assets could be taken into account as well.
• Capital: If your business lacks the revenue or capital to repay a loan, it could be a reason you were denied.
• Capacity: If your business lacks the capacity to repay a loan because of existing debts, the bank may not approve another loan until your existing debt has lowered.

Other reasons for a loan denial could lie in the supporting documentation accompanying your application. Common supporting documentation requirements include a business plan, three to five years of business and personal tax returns, business bank account statements, financial statements and projections, personal and business credit reports, and legal documents such as contracts, leases, licenses, permits, and articles of incorporation. If you were missing any of these or if they were unorganized or insufficient, the bank may not have complete information to evaluate your ability to pay off a loan.

Step 2: Make Adjustments and Apply Again

Fortunately, there are ways to impact and improve most of these issues. A good place to start would be working to improve your personal and business credit. While improving your business’s financials or acquiring more assets may take time, you can have the most immediate impact in this area. Many banks like to see a personal credit score of 700 or above. A quick way to improve your score would be to pay down your debts until you are using under 30 percent of your available credit. As for improving your business credit, making on-time payments and asking your vendors to report their positive payment experiences with you to credit bureaus is one way to begin having an impact on your business credit.

To improve collateral, evaluate your existing assets. Are there investments you could make that would benefit your business and serve as good collateral when applying for a loan? For example, if you could purchase a piece of equipment that would automate part of your business processes, that might be an option to consider.

To improve capital, work will need to be done on your business’s financials. Three key areas to examine are revenue, profits, and existing debts. Can you increase sales to increase revenue? Can you cut down on expenses to increase profits? Can you pay off existing debt? Concentrating on any or all of these key areas can improve your chances of being approved for a loan the next time around.

To improve capacity, you will want to work on your Debt Service Coverage Ratio. This is a measurement of cash available compared to debt and is used by banks to determine whether you have the ability to re-pay your loans. More simply put, it measures your income against your existing debts and obligations. Ways to increase this number (a good goal is a ratio greater than one) are either to increase income or pay down debts.

Make sure you have all the required supporting documentation and that it is orderly, legible, and complete. Contact the bank directly to find out their specific requirements ahead of time. If your business plan is incomplete or inadequate, make revisions before reapplying.

Consider waiting six months to a year before reapplying, if possible. If the length of your credit history or the age of your business was an issue with your first application, the solution could be simply giving it some time.

Step 3: Know Your Options

It is recommended that you try a different bank than the one where you originally applied. Unless it has been more than a year and your financial situation has drastically changed, your previous denial with the same bank could be held against you. Smaller banks historically have higher acceptance rates than larger chain banks.

If you have struggled to get a loan from a bank, consider financing with online or alternative lenders. According to the PCA Index, 71 percent of respondents had success securing financing with an online lender. Many online lenders are more lenient when evaluating credit scores and are more open to newer businesses. However, you can often expect shorter repayment periods with higher interest rates. There are also a variety of nonprofit lenders geared toward small businesses in disadvantaged communities.

Grants are typically offered by state, county, and local governments, or by private organizations. A grant differs from a loan or a credit card in that it does not need to be repaid. However, the application process typically requires a lot more effort. First, you need to find out what grants you qualify for. Examples include grants for minority-owned businesses, nonprofits, businesses working to become more sustainable, or businesses in economically depressed areas. Second, you will need to write an in-depth proposal describing your objectives in acquiring the grant and specific ways the money will be used. Beware of websites and internet companies promising free money to businesses. If you are being asked to pay for information on a grant, it is probably illegitimate. Information on a grant should be publicly available.

A Merchant Cash Advance (MCA) is upfront cash offered in exchange for a percentage of future debit or credit card sales. If you have a business that does a large amount of daily credit or debit card sales, such as a restaurant or retail store, this could be an option to consider. MCA lenders are usually more flexible if you are a new business, have poor credit scores, or little collateral. However, many businesses consider MCA “loans” a last resort option. If you are unable to pay them off quickly, they often have fees three times the normal rate for a loan. While you can get cash quickly with an MCA – sometimes in a day or two – you may end up paying several times the amount you borrowed in the long run.

Asset-based lenders loan business funds that are secured by collateral, such as accounts receivable, inventory, equipment, or property. The amount received is usually based on the face value and liquidity of the collateral. If your capital or capacity is considered too low for a traditional loan, you may qualify for an asset-based loan. Many companies consider asset-based loans to offset cash flow issues associated with rapid growth or expansion. Asset-based loans may carry fees in addition to interest, such as a due diligence fee for valuation of the asset(s) in question. Assets being used as collateral for another loan or in danger of being repossessed due to a legal issue may not be used as collateral.

If you have not yet established business credit for your company, a business credit card could be a good way to do that. Using a business credit card will impact your business credit scores, but some may impact your personal scores as well, so read any agreement carefully before you acquire a business credit card. While most business credit cards charge interest, many have an interest-free period and some do not require an annual fee. You also may be able to transfer higher interest debt to a card with a low or nonexistent balance transfer fee. Other perks you may receive with a business credit card include cash back, air miles, or hotel rewards. The credit scores you need to qualify for a business credit card often depend on the quality of benefits you can receive from using the card.

Loans for larger amounts are sometimes more easily approved because the bank’s cost of monitoring a loan is often the same, regardless of the amount borrowed. If you were denied for a micro-loan (less than $50,000), a line of credit is a more short-term, flexible option than applying for a loan. Similar to a credit card, in most cases you only owe interest on the outstanding balance and the funds are available to you again after you have paid them off. However, the interest rates on lines of credit are usually lower than credit cards.

As you can see, being denied for a loan is not an impossible obstacle to overcome for your small business. There are many ways that you can improve your approach to the lending process to be more attractive to banks and, in the short term, there are multiple options available for business financing. There are also a lot of habits you can develop now that will make your business more attractive before you need financing, such as impacting your credit and carefully managing your business finances. That way, when the time comes, you will be ready to apply for a loan.