It’s no secret that small businesses drive the U.S. economy, and their stability and ability to thrive is crucial for everything from job creation to increased consumer spending. That’s why politicians so often harp on the topic of raising up the country’s small businesses to a state of consistently positive growth and debate the best ways to do so.
Recent research from Pepperdine University noted that “GDP growth in highly developed economies is significantly driven by the private sector and by entrepreneurial activity in particular.” In 2014, many small businesses aim to solidify this research by improving their business prospects this year—but to do that, they often need more capital than they are able to supply or raise on their own.
According to this research, “Nearly 89 percent of business owners report having the enthusiasm to execute growth strategies, yet just 46 percent report having the necessary financial resources to successfully execute growth strategies.”
This in turn means that small businesses tend to rely on loans to help them grow their businesses. The university reports that among small businesses with less than $5 million in revenue that sought a bank loan in the previous three months, 39 percent were successful. This number may seem grim, but this percentage actually increased from 34 percent reported in a fall survey.
But for the other 61 percent of small business owners who did not get approved, they are often left with one burning question—Why? Since lenders don’t often take the time to explain the reasons for rejection, small businesses never really know what was wrong with their business or application to not achieve approval.
That doesn’t have to be you and your business. We’ve put together a list of 10 ways that you can lessen the chance of your small business loan being rejected. Take a look and see if your application has missed any of these crucial steps.
1. Ensure You Actually Need The Financing
Many businesses get into trouble because they don’t actually need the financing they are seeking. Borrowing too much money can be dangerous for a small business, and it can be one of the biggest mistakes you can make as a business owner, according to Brian Hamilton, CEO of Sageworks, Inc. Certainly, you will have times when borrowing money makes sense, but he says that those times are limited.
He recommends that you be able to answer “yes” to the following two questions if you are thinking about borrowing money:
– Is your business actually profitable?
– Can you easily service the debt?
If your business is not profitable, obviously you will not be able to pay back the debt you owe, and this can get you into a sticky situation. Also, if you can’t service the debt, this may be another sign that this is not a good time to take on a business loan.
The bottom line is that you should only borrow money when you are confident that you can turn a profit on the loan that you bring in. When deciding whether or not to approve a loan, bankers are more interested in whether you can pay the money back than whether or not it is a good investment for your business.
It is imperative that you figure out if you actually need the financing before seeking a loan. In the end, if you actually do need the loan and can afford to take on the debt, you will have a better chance at getting it approved.
2. Provide Detailed General And Financial Information
When it comes to a loan application, you need to have all of your plans and numbers both in order and on display. You really can’t and shouldn’t hold anything back in terms of your business plan, particularly how you will use the loan and how much you need to accomplish your goals. The more specific you are, the better.
You need to realize that you’re going to need to share all of your financial information as well—even those numbers here and there that you’d rather hide from the lender’s eye. In addition to the financial background of your company and future growth plans, your lender may also request your personal financial information, which they often do. Providing this information from the beginning greatly reduces the amount of time necessary to process your loan and increases your chances for approval.
Lenders take kindly to detail and preparedness when it comes to providing all the information necessary to apply for a loan, and you’ll have a much better shot at getting yours approved if you do.
3. Determine Your Global Coverage Ratio
To find out if you can actually service the debt you would take on, you need to determine your global coverage ratio, which banks usually examine when considering giving a loan to a small business. This ratio takes into account both your personal finances and the finances of your business.
To calculate this ratio, follow these steps (provided by Sageworks):
- Assuming your business has no current debt, start with your gross income, any wages you’re taking from your business and any other sources of income, such as rent on property.
- Add to this your business’ earnings before interest, taxes and depreciation.
- Divide the result by the total of both your existing personal debt (mortgages, car loans, etc.) and the principal and interest you would owe on the new business debt.
To safely be able to service the debt, your resulting ratio should be more than 3, though even above 2 means you’re in fairly good shape. Where you run into trouble is if your ratio falls below 1.5, when most banks won’t approve the loan without charging such high interest rates that it may not be worth it.
4. Ensure High Quality Of Your Earnings Or Cash Flow
Research from Pepperdine reported that the top reason why banks rejected a business loan application was the quality of the applicant’s earnings or cash flow.
According to Forbes, “’Quality of Earnings’ can mean different things to different lenders. But generally, having high-quality earnings means a company’s financial statements show stable, persistent and predictable earnings that are related to the core business.”
Quality of earnings is where many small businesses run into problems with getting their business loan approved. For small businesses, sales are often generated by a smaller number of customers, or their earnings look weak in general, so this can be an issue when applying for a loan.
5. Consider Your Amount Of Collateral
Another aspect of your business that banks will look at is the collateral of your small business. The Pepperdine survey reports that insufficient collateral is actually the second-highest reason that business loans are rejected.
According to Forbes, “The Pepperdine 2014 survey found that banks required collateral 100% of the time for loans of $1 million, but that percentage dropped to 63% for loans of $100 million. […] If a business doesn’t have much in the way of equipment, buildings, inventory or accounts receivable, the lender will have fewer options for repayment of the loan, making the deal unattractive.”
Without collateral to potentially sell if your business goes south, this makes your loan application appear less appealing to a potential lender. This is something you need to consider when going after a small business loan, as this could either help or hurt your chances depending on your particular business.
6. Seek Out Assistance From The Small Business Administration
Lenders at the SBA are a great resource for small businesses, and they can counsel you throughout the process, each step of the way. By using the knowledge you gain from your interactions with the SBA, you will be better informed when it comes time to get your loan approved, and the more you know, the better a position you’ll be in.
7. Don’t Go Overboard With Expenses On Your Taxes
While many small businesses attempt to minimize their taxes by including more expenses, this can actually hurt an applicant when he or she tries to get a business loan. If you overspend on expenses for your business, while you can write them off, you still have to pay for them, and too much money going out will hurt your net income. If your expense numbers are not realistic or well-researched, a lender will be more hesitant to give you a loan.
8. Go Local
While there are lending institutions of all sizes, community lenders are often most appreciative and best equipped to handle exactly how your company works within the context of the local business economy. Because they have certain insights into how the local business environment works, they may be better suited to more fully understand your business situation in a local framework. Have you contributed to the community outside of work? Even better, as you’re demonstrating your commitment to the community you plan to serve.
9. Research Alternative Financing For Short-Term Needs
When small businesses can’t receive a traditional loan and are having issues with cash flow, they are beginning to turn to alternative financing to bridge the gap in the short term. Asset-based lending and factoring are two of these options.
According to Inc., asset-lending is akin to the traditional loan process, wherein the lender will consider accounts receivable, inventory values and fixed assets to determine creditworthiness before issuing a line of credit. Factoring, on the other hand, means that your business would sell its accounts receivable to receive a short-term loan of up to 80 percent of your business’ value.
One issue? The interest rates on these types of loans tend to be at least double what you’d pay for a traditional loan, according to Inc.
10. Keep In Mind Other Reasons A Bank May Not Loan Your Business Money
According to the Pepperdine survey, after quality of earnings or cash flow, insufficient collateral and debt load, there are several other more minor—but still important—reasons why a bank may reject your loan application:
– Size of company
– Customer concentrations
– Insufficient credit
– Size or availability of personal guarantees
– Insufficient operating history
– Economic concerns
– Insufficient management team
– Weakening industry
It may seem a bit mind-boggling just how many aspects of your business, its operations, and its finances that you’ll have to keep in mind while applying for a small business loan. But because being approved for a loan can be tricky, it is important that you do your homework and keep these steps in mind as you go about considering your application and its potential acceptability.
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