Over the past five years, there has been an increase in sources of business financing in the US. Specifically, the alternative lending market has proliferated to meet the needs of entrepreneurs who do not have the credit (personal or business) or the operational capacity to obtain the approval of traditional bank financing. Although useful in the short term, many of these alternative sources of loans “trap” business owners in loan structures with high payments and abnormally high interest rates. These two factors often cause the company more damage than anticipated by restricting and sometimes significantly decreasing free cash flow. Traditional bank financing continues to be the best option for entrepreneurs due to the low cost of money and the flexibility to mitigate issues with reimbursement and settlement. In this article, we will focus on the top 2 reasons for business loan denials in order to equip business owners with the information to produce and present business loan proposals that are concise, relevant, and factual.
(1) Unresolved Personal and Business Credit Profile (High Credit Risk)
Most business owners and individuals do not have a solid understanding of their credit profiles. Although banks have become more proprietary in their credit scoring systems, the foundation remains the credit report for both consumers and businesses. Not only is it enough to know your credit profile, but you must also have valid explanations for any reported problems. Ideally, you want to resolve these issues as much as possible before submitting your business loan proposal.
Your personal and business credit profile also presents a payment pattern to the lender and is a key component of business loan approval. If credit reports show a pattern of non-payment or mostly non-payment as agreed, then the chances of being denied a business loan are quite high. One way to improve your payment pattern is to close unused or unnecessary lines of credit or lower existing amounts of credit, such as credit cards, or open lines of credit where appropriate.
(2) No business plan equals no proof (high management risk)
Lenders like to see business owners organized and focused on their businesses, and a great way to reveal this is to present a solid business plan. This plan should highlight your business objectives, especially those that include the proposed loan, in the executive summary. Many times loan proposals consist of a phone call or a brief conversation with the lender with nothing in writing. Always provide the lender with a brief statement disclosing the loan opportunity or a business plan that includes an explanation of how the loan proceeds are used and repaid.
Also, describe the opportunity to obtain financing as a means to an end. In the past, I have experienced how entrepreneurs only offered plans that revealed how and why the financing was needed without revealing much else. To improve your chances of approval, provide the banker with a complete picture of the impact of the financing in both the short and long term.