Starting and building up a small business can come with many highs and lows. One aspect that can become overwhelming is the need for additional funding. Many business owners look to obtain financing when an increase in cash flow is needed, or if they are expanding or upgrading the business. However, there are unfortunately times when a business owner may be denied a small business loan.
If you find yourself in this situation, it is important to know what to do next and to keep in mind that there are other options available. Below we outline what to do, and what to consider, in the event you are denied financing for your small business.
Find Out Why You Were Denied
Once you’ve been denied for a business loan, it’s important to find out why. Only then can you determine if the denial was made in error, or if there are things you can change about your business’s financial situation in order to be reconsidered for the loan.
Many lenders have their own criteria for issuing loans. Some are more stringent than others. If you don’t receive an automatic notification explaining why you were turned down, ask your lender to explain. Here are some common reasons a small business may be denied a loan:
• Poor business credit score or personal credit score
• New business with lack of financial history or credit history
• Business that’s part of a risky or new industry
• Lack of preparation for the loan application
• History of inconsistent cash flow
Improve Your Personal Credit Score and Business Credit Score
Once a year, consumers can get a free copy of their personal credit report from the three major credit bureaus – Experian, Equifax, and TransUnion. Your credit report outlines things like your borrowing history, payment history, debt-to-credit ratio, and the number of recent credit inquiries you’ve had. All of these factors influence your credit score. In many cases, your personal credit history can play a role in a business loan decision. Typically though, a lender will also want to look at the credit history of your business specifically. And while many people have a good idea of what’s in their personal credit report, many business owners don’t have a clue what their business credit score looks like.
Just as there are three main consumer credit bureaus, there are three major business credit bureaus. These are Dun & Bradstreet, Equifax Business, and Experian Business. A business credit report will likely be one of the first items a lender pulls to check your business’s credit history before deciding to grant you a loan. For this reason, it’s a good idea to review your business credit reports before applying for a loan. But if you’ve already applied for business financing and have been denied, your business credit report can likely shed some light on why. The good news is that if your business credit score is unfavorable, you can work toward improving it by paying existing credit card and loan bills on time and using your business credit wisely. Just remember that in order for it to impact your business credit report, the credit needs to have been established in your business’s name. Personal loans and personal credit cards will not count toward your business’s credit.
Consider the Five Cs of Credit
In addition to your credit scores, here are some other things to consider if denied financing for your business. Knowing how a lender will evaluate your business for creditworthiness can help you understand what areas to improve upon before submitting another loan application:
• Capacity. Lenders will explore the amount of debt you currently have, the ability of your business to generate a positive cash flow, and your credit repayment history to determine your capacity to repay the loan. Typically, they will expect you to have a debt service ratio of at least 1.20. This means you’re generating $120 for every $100 you have in debt. If you have a debt ratio lower than this, it may be worthwhile to analyze and consider options for generating a steadier cash flow and higher debt capacity.
• Collateral. Lenders want to feel comfortable that they can get their money back if you default on the loan due to going out of business, bankruptcy, etc. Although loans backed by the Small Business Administration don’t always require collateral, loans issued by private financial institutions may. If a lender requires collateral, they will likely consider which assets you own that they can place a lien against in the case of default. If an asset is being used as collateral, its value will need to be more than the loan amount.
• Capital. Lenders will examine the amount of money you’ve put into your business, how much capital you have on hand, and the amount of your receivables. If you do not have a lot of capital in your business or personally, the loan could be seen as high-risk.
• Character. Your business and personal history, reputation, and references all play a part in the loan evaluation. A failure to pay your bills promptly or a poor reputation in your industry may impact a lending decision. Even if your business has a good credit score, if you have had a past business go bankrupt or defaulted on a personal loan unrelated to the business, it could be a red flag to the lender and result in a loan denial.
• Conditions. Lenders are in the risk mitigation business. If your business credit is less-than-perfect, that doesn’t mean you can’t get a loan. It just means they may place additional conditions on it. For example, a lender might grant you credit at a higher rate, ask for more collateral, or ask you to personally guarantee the loan. If you know when applying for the loan that your business or personal credit score is poor, you should consider discussing these conditions before they are brought up by the lender.
Should I Try a Different Bank?
Another important thing to keep in mind is that different lenders will have different criteria for lending. Risk tolerance varies by financial institution, and some loan requirements may have more to do with a lender’s current financial situation than they have to do with your own. For this reason, it may be worthwhile to try your luck with a different lender if your initial financing request is denied.
Before you apply for another loan at a different financial institution however, take the time to find out why you were initially turned down. This will help to maximize your chances of being successful with a loan application elsewhere. You also don’t want to have numerous denied business loans across several institutions. Keep in mind that each time you apply, there is likely to be a “hard pull” on your credit reports. If you start to rack up many of these credit inquiries, it can negatively impact your credit score and further decrease your chances of being approved for a business loan.
Alternative Lending Sources
Some reasons for denial, such as the number of years you’ve been in business or being in an unestablished industry, will be more difficult to improve than something like failing to pay your bills on time. If the reason for your rejection is not something you can easily work to change, you may want to explore alternate forms of financing, such as venture capital, crowdfunding, or angel investors.
If you are unable to secure a business loan from a traditional bank, another option is to consider taking out a personal loan and using it to fund your business. However, you should keep in mind that doing so could put your personal finances at risk.
Another potential option is to consider a local community bank or mutual bank in your area. Oftentimes, these financial institutions may be more willing to work with a small business than a larger bank would. Community banks may see your business as an opportunity to reinvest in their local area which can benefit both parties. They may also be willing to work with you throughout the application process to find the loan that best suits your business and financial situation, or steer you toward local business resources that could help you overcome some of your existing financial challenges. This is important to consider if your business is just starting out or if you have no prior experience applying for a business loan.
Being denied a business loan is certainly not likely to be part of your business plan, but it is important to not be discouraged if you find yourself in this situation. Take a deep breath and consider what you have the ability to change before you apply again. Above all, it’s important to find a lender that can be a true partner to your business, and a trusted financial resource for years to come.
If you find yourself in this situation, it is important to know what to do next and to keep in mind that there are other options available. Below we outline what to do, and what to consider, in the event you are denied financing for your small business.
Find Out Why You Were Denied
Once you’ve been denied for a business loan, it’s important to find out why. Only then can you determine if the denial was made in error, or if there are things you can change about your business’s financial situation in order to be reconsidered for the loan.
Many lenders have their own criteria for issuing loans. Some are more stringent than others. If you don’t receive an automatic notification explaining why you were turned down, ask your lender to explain. Here are some common reasons a small business may be denied a loan:
• Poor business credit score or personal credit score
• New business with lack of financial history or credit history
• Business that’s part of a risky or new industry
• Lack of preparation for the loan application
• History of inconsistent cash flow
Improve Your Personal Credit Score and Business Credit Score
Once a year, consumers can get a free copy of their personal credit report from the three major credit bureaus – Experian, Equifax, and TransUnion. Your credit report outlines things like your borrowing history, payment history, debt-to-credit ratio, and the number of recent credit inquiries you’ve had. All of these factors influence your credit score. In many cases, your personal credit history can play a role in a business loan decision. Typically though, a lender will also want to look at the credit history of your business specifically. And while many people have a good idea of what’s in their personal credit report, many business owners don’t have a clue what their business credit score looks like.
Just as there are three main consumer credit bureaus, there are three major business credit bureaus. These are Dun & Bradstreet, Equifax Business, and Experian Business. A business credit report will likely be one of the first items a lender pulls to check your business’s credit history before deciding to grant you a loan. For this reason, it’s a good idea to review your business credit reports before applying for a loan. But if you’ve already applied for business financing and have been denied, your business credit report can likely shed some light on why. The good news is that if your business credit score is unfavorable, you can work toward improving it by paying existing credit card and loan bills on time and using your business credit wisely. Just remember that in order for it to impact your business credit report, the credit needs to have been established in your business’s name. Personal loans and personal credit cards will not count toward your business’s credit.
Consider the Five Cs of Credit
In addition to your credit scores, here are some other things to consider if denied financing for your business. Knowing how a lender will evaluate your business for creditworthiness can help you understand what areas to improve upon before submitting another loan application:
• Capacity. Lenders will explore the amount of debt you currently have, the ability of your business to generate a positive cash flow, and your credit repayment history to determine your capacity to repay the loan. Typically, they will expect you to have a debt service ratio of at least 1.20. This means you’re generating $120 for every $100 you have in debt. If you have a debt ratio lower than this, it may be worthwhile to analyze and consider options for generating a steadier cash flow and higher debt capacity.
• Collateral. Lenders want to feel comfortable that they can get their money back if you default on the loan due to going out of business, bankruptcy, etc. Although loans backed by the Small Business Administration don’t always require collateral, loans issued by private financial institutions may. If a lender requires collateral, they will likely consider which assets you own that they can place a lien against in the case of default. If an asset is being used as collateral, its value will need to be more than the loan amount.
• Capital. Lenders will examine the amount of money you’ve put into your business, how much capital you have on hand, and the amount of your receivables. If you do not have a lot of capital in your business or personally, the loan could be seen as high-risk.
• Character. Your business and personal history, reputation, and references all play a part in the loan evaluation. A failure to pay your bills promptly or a poor reputation in your industry may impact a lending decision. Even if your business has a good credit score, if you have had a past business go bankrupt or defaulted on a personal loan unrelated to the business, it could be a red flag to the lender and result in a loan denial.
• Conditions. Lenders are in the risk mitigation business. If your business credit is less-than-perfect, that doesn’t mean you can’t get a loan. It just means they may place additional conditions on it. For example, a lender might grant you credit at a higher rate, ask for more collateral, or ask you to personally guarantee the loan. If you know when applying for the loan that your business or personal credit score is poor, you should consider discussing these conditions before they are brought up by the lender.
Should I Try a Different Bank?
Another important thing to keep in mind is that different lenders will have different criteria for lending. Risk tolerance varies by financial institution, and some loan requirements may have more to do with a lender’s current financial situation than they have to do with your own. For this reason, it may be worthwhile to try your luck with a different lender if your initial financing request is denied.
Before you apply for another loan at a different financial institution however, take the time to find out why you were initially turned down. This will help to maximize your chances of being successful with a loan application elsewhere. You also don’t want to have numerous denied business loans across several institutions. Keep in mind that each time you apply, there is likely to be a “hard pull” on your credit reports. If you start to rack up many of these credit inquiries, it can negatively impact your credit score and further decrease your chances of being approved for a business loan.
Alternative Lending Sources
Some reasons for denial, such as the number of years you’ve been in business or being in an unestablished industry, will be more difficult to improve than something like failing to pay your bills on time. If the reason for your rejection is not something you can easily work to change, you may want to explore alternate forms of financing, such as venture capital, crowdfunding, or angel investors.
If you are unable to secure a business loan from a traditional bank, another option is to consider taking out a personal loan and using it to fund your business. However, you should keep in mind that doing so could put your personal finances at risk.
Another potential option is to consider a local community bank or mutual bank in your area. Oftentimes, these financial institutions may be more willing to work with a small business than a larger bank would. Community banks may see your business as an opportunity to reinvest in their local area which can benefit both parties. They may also be willing to work with you throughout the application process to find the loan that best suits your business and financial situation, or steer you toward local business resources that could help you overcome some of your existing financial challenges. This is important to consider if your business is just starting out or if you have no prior experience applying for a business loan.
Being denied a business loan is certainly not likely to be part of your business plan, but it is important to not be discouraged if you find yourself in this situation. Take a deep breath and consider what you have the ability to change before you apply again. Above all, it’s important to find a lender that can be a true partner to your business, and a trusted financial resource for years to come.