Your company may require additional cash to meet its operational or expansion goals. This funding could come from either equity or debt. Both have advantages and disadvantages, although debt/loan is often less expensive than equity.
Your bank or another financial organization is the typical source of debt funding. Unfortunately, not all small business loan applications are granted, even if the company has excellent potential and has been running smoothly for years.
However, most small firms begin with no credit, whether because they are new to the business sector or have never sought a loan before. Obtaining approval for a small business loan may appear to be a challenging task, particularly if you have less-than-perfect credit or if your company does not appear to be profitable in the short term.
There are several reasons why lenders may not grant your loan. Understanding these reasons will help you hone your pitch to lenders or find better financing solutions that better meet your business needs. The following are the nine most common reasons for a small business loan denial.
1) Bad credit
Unsurprisingly, your credit score is a principal factor in obtaining a business loan. Lenders will want to see that you have a history of making on-time payments and making sound financial judgments. If you have recently missed a few payments or have a history of loan defaults, your prospects of getting a loan are slim—at least in the short term. The good news is that poor credit can be repaired with time and effort. Start by paying off any existing debts you owe and avoid taking out new loans to improve your credit score. Lenders will regain their trust in you, making it easier to secure company funding when you need it the most.
Businesses with a long history of past due payments or debt default may be less likely to qualify for new loans. Even if you can establish your ability to repay a business loan, lenders may hesitate to give you extra debt. You can demonstrate your creditworthiness to prospective lenders by boosting your credit score and actively working to establish a solid payment history.
2) Inadequate collateral
Most lenders will not lend you money if you do not have something of actual worth to offer in return. So, suppose you apply for a loan and do not have any collateral (property, house, savings). In that case, it may be challenging to obtain a small company loan. The good news is that it is entirely feasible. There are other financing options available for small businesses with no collateral. Still, they can be challenging to identify and often come with higher interest rates. It also depends on what you intend to use as collateral once your company is up and running; many lenders require some form of security before offering to fund, so putting in the effort now may put your company in a better position when the time comes.
Lenders want assurances that they will recuperate their investment if you default on your loan. If you do not have any assets (home, car, etc.), it can be tough to persuade a lender that you can repay them. Furthermore, if you establish or grow a firm with little personal resources or assets, banks may view it as risky.
3) Inadequate revenue
Do you have a startup concept but do not know how to fund it? If this is the case, you should be aware that to qualify for most loans, you must demonstrate your potential to generate money. Just saying you will do it is not enough. Revenue is considered your best indicator of business success. Lenders will not approve a loan if you cannot demonstrate that your business has generated sales (either currently or in the past). As hard as it might be, before starting a business, make sure it is feasible. Figure out how much money you will need and if what you are selling makes sense in today’s marketplace. Be prepared with financial data and detailed marketing plans when asking potential investors or creditors for money.
Suppose you are not bringing in enough money to cover your business expenses and make loan payments. In that case, a lender will not be eager to give you a business loan. For example, if you need N500,000 to start your business but are only bringing in N300,000 per year (before paying yourself a salary), it would be hard to convince a lender that you will have enough revenue (and income) two years from now.
4) Lacking a business plan
Many lenders, including those at banks, rely on your business plan to better understand your business. Many small business owners do not realize that they need to create their business plans before starting their funding process. This means you can do everything right—shop around and compare loan offers—but if you have not created a formalized plan or written a comprehensive financial statement first, it can be tough to persuade lenders to give you money. A suitable lender will want to see your long-term strategies and day-to-day plans for success in writing before offering a loan. Still, it never hurts to start with what is before you.
You cannot expect a lender to take your small business seriously if you have not taken it seriously yourself. Do your investigation and prepare a clear plan before obtaining money. Not only does having a great business plan on hand make it easier to obtain finance, but it also ensures that once you have secured capital, you will have clear guidance to keep your organization on track.
5) Lack of experience
A lender may be wary of lending you money if you are just starting out. They will want to see that you have experience running at least one other firm successfully, even if it is not linked to your new endeavour. Alternatively, having some meaningful work experience elsewhere is also a promising idea—you may identify your current position on your loan application and talk about how you want to incorporate those talents into your new firm. If you are self-employed and do not have any employees (or even clients), make sure you explain how and why it matters; self-employment does not necessarily guarantee an automatic pass on your loan application.
Lenders frequently want to see that you have owned and run a business before. If you haven’t done so, it will be difficult to obtain loan approval. To maximize your chances of getting approved, make sure you have at least five years of industry experience before applying for a loan.
6) Inadequate cash flow forecast
One of your primary considerations when applying for a small company loan should be whether you have enough cash flow to repay the loan. Inadequate cash flow can be caused by a variety of factors, such as slow sales growth or an inability to raise pricing due to local economic conditions. Lenders will refuse future loan requests if you cannot demonstrate that you can meet your monthly expenses. As a result, one of the first tasks in creating a business plan should be determining what is required to maintain a proper cash flow – and then ensuring that those figures add up.
The lender has doubts about your company’s ability to repay a loan. One of two things usually happens here: either you do not have enough cash flow to cover what you spend plus interest and principal payments, or you have enough cash flow but not enough to cover what you spend plus interest and principal payments.
7) Instability in the industry
One of the main reasons loan applicants are denied is that they work in an unpredictable business. The lender may be concerned about your company’s ability to repay its loan. Most lenders will not invest in something that has the potential to become obsolete or lose appeal unless you have a genuinely original idea. Lenders want to know that your firm is secure and will continue to function for the duration of your repayment plan. This may seem obvious, but even many successful small firms that are solid on paper might face issues due to market trends and other market variables beyond their control. An ideal business should weather these storms and emerge victorious when one of its competitors fails.
If your sector is unsteady, you will have difficulty securing a small company loan. While some banks may make loans to industries known to change seasonally, such as tourism and education, many others will not. If your industry has a history of sharp difficulties, lenders may be reluctant to lend to you.
8) Inadequate preliminary costs
One of the most common reasons people fail to obtain a small business loan is a failure to accurately estimate their initial costs. Most entrepreneurs overstate their initial outlay. As a result, these additional charges appear on their application and prohibit them from being approved. People frequently report hardware and inventory as startup expenses when they are, in fact, operating expenses. Before applying for a small business loan, make sure you have a realistic idea of your starting costs so that your application is not misleading or incorrect.
If you are looking for a loan to fund your business, make sure your estimated expenses are reasonable. New entrepreneurs, for example, frequently underestimate the amount of money required to create a functional prototype of their product or to set up a basic website. Or they overestimate what they can accomplish in a brief period. Far too often, new firms fail because their founders spend all their money getting ready for opening day and have none left over when things go wrong.
9) There is no documented credit history.
When asking for company financing, the lack of a record of accomplishment is usually a key barrier. Suppose you have never borrowed or utilized credit. In that case, it will be difficult to obtain approval for a business loan because traditional lenders want to know that you can manage debt responsibly. Many small businesses start out by financing their operations with personal credit, which can help you build your credit history if you use them correctly and pay off each bill on time each month. Another option is to find an alternative lender who will take entrepreneurs with little or no credit history. Still, you may have to do more explaining why you have not utilized conventional lenders to convince them that you are financially responsible enough to deserve a company loan.
Lenders are less inclined to take a chance on you if you do not have confirmation of your previous credit history. It’s simple: if you don’t have one, get one by taking out a small personal loan and repaying it right away. Make it clear to your lender that it is not meant to be a continuing line of credit but to serve as proof of your ability to repay debt. Lenders will reward you with lower interest rates or approval if they see you are responsible with debt.
If you are denied a loan, this does not necessarily imply that you do not have a viable company plan. Instead, concentrate on refining your business plan by addressing some of these challenges. Reapply to lenders and investors after you’ve made some improvements—you might get approved the next time!
When it comes to submitting a business loan application, many do not even try because they fear being denied.
And, while we cannot guarantee that your application will be approved, there is no reason to wait and risk it. We will look over your application and give you feedback on what should be revised or changed to help increase your chances of approval.