Top 7 Reasons Why Small Business Loan Applications Get Rejected
Starting a small business and sustaining it requires constant cash inflow and proper financial management. So whether you are starting a new business or expanding the existing one, you need adequate access to funds. In this regard, opting for a business loan is advantageous because you cannot independently finance all business operations. However, it can be a great setback when banks or financial institutions reject your loan application.
In that case, working on the factors that influence the loan approval process can enhance your chances of getting one. Scroll down to check out the few reasons why business loan applications face rejection.
Why do Small Business Loan Applications Get Rejected?
With a business loan, you can take, expand or diversify your small business. Depending on your objective, you can get a business loan of a suitable amount and repayment duration that work best for your goal.
However, business loan application approval is directly related to crucial aspects like your business plan, cash flow, proper paperwork, and many more. Here are the top seven reasons that can create hindrances in the path of your small business loan approval.
- Unsuitable Business Plan
When it comes to business loan approval, your business plan plays an important role. The lending institution evaluates the feasibility of the business projection and the overall business plan. If you submit an inappropriate business plan that appears to be risky or impractical, they might reject your loan application.
To avoid such issues you must involve expert professionals to make a flawless business strategy. Including different components like target customers, expected profit margins and revenue growth map in the business plan help your lender to get a clear picture of your understanding of the business and how you want to utilise the amount. This also provides them confidence about your loan repayment capability.
- Poor CIBIL Score
Many small businesses face business loan rejection due to poor credit scores. Your credit or CIBIL score is a big factor in determining if lenders will approve your loan request. The score indicates how the founder and company have dealt with debt in the past. So after submitting your loan application lenders will take into account both your personal and business credit score. A CIBIL score above 700 is usually considered good by lenders.
Keeping a high credit score is one of the most effective ways to avoid loan rejection. To maintain a healthy credit score you must repay your loan EMIs, and credit card bills on time. Additionally, you can diversify your credit portfolio, keep the debt-to-income ratio low, avoid too many loan applications simultaneously, and keep your credit utilisation ratio low. Maintaining these elements may boost your credit score instantly, building a strong credit history.
- Lack of Adequate Cash Flows
Your business cash flow plays an important role in determining your loan repayment capability. Poor cash flow may pose you as a high-risk borrower and financial institutions lose confidence in your business when your company’s cash flow is weak.
In order to avoid such issues, improving your cash flow by reducing unnecessary expenses is a viable option. In this regard, when you apply for a business loan, your cash flow statement must be in order. Doing this will also help you improve your management and accountability abilities, making you a better candidate for a loan.
- Absence of Collateral
The absence of collateral is yet another factor that contributes to the rejection of loans for many business entities. When you are applying for secured business finances it is essential to deposit collateral against your loan amount. Any high-value asset like a home inventory, machinery, real estate, etc., can fall into this category. Lenders have the legal right to sell these assets and get their money back if an entrepreneur fails to repay the loan amount on time. Lenders might deny your loan application if you do not provide sufficient collateral.
In such a case, the best possible solution is to find a lender offering an unsecured business loan. If you apply for an unsecured loan, the lenders may impose penalties or take legal action if you fail to repay the loan amount but you have pledged no assets that you stand to lose.
- Inadequate Documentation
To receive approval for a business loan it is essential to provide all necessary and required information. Your lender will thoroughly assess a variety of documents like company bank accounts, personal and company tax returns, financial statements, contracts, legal documents, and many more. Due to a lack of experience or business vintage, many small organisations often fail to provide documents that are effective, accurate, and appropriate, resulting in the rejection of the loan application.
In this regard, before applying for a loan, it would be ideal to check the required documents from the lender and ensure to get them in order. This would reduce the amount of correspondence between you and your lender.
- Early-Stage or New Business
Lenders usually prefer businesses that have some years of experience. Availing of a business loan for your early-stage business can be quite difficult. Your application for a business loan may get rejected due to the lender’s policies if your new business does not have a long history of cash flows and inadequate performance records. Even if you have an appropriate business plan and good finances, lenders might not be able to provide you with a loan until your business is in the growth or maturity stage.
In that case, before applying for a business, you should ideally spend a few years in business. During this period, you will be able to build sustained cash flow and credit flow that can help you get a good amount of business loan.
- Risky Industry
If your business is highly volatile and dependent on external factors like market trends, seasons etc., financial institutions may not want to provide a loan to your business. For instance, if you want to start a stock brokerage business, the operation will always be influenced by market fluctuations. This makes financial institutions more reluctant to accept your application as they believe your company is highly risky.
Therefore, it is essential to run a thorough evaluation of your sector-specific business. If you are facing challenges in availing funds because of the industry, you can find appropriate sector-specific lenders who are willing to give loans to businesses in your industry.
As you can see there are several reasons why small business face rejection of small businesses loans. Being aware of these reasons can help you to avoid making any mistakes and will assist you in obtaining credit without any hassle.
What can I do if my business loan is not approved?
If lenders reject your business loan application, first you need to evaluate the reason for denial and ensure that you are applying for the right financing. Then after evaluating all factors, act on that particular area and apply for a new loan application again. If required, you can go to another lender.
Is a small business loan an unsecured or secured loan?
Depending on an individual lender’s policies a small business can secured or unsecured loans. A small business is secured when backed by specific collateral, such as assets like inventory, real estate, etc. Whereas unsecured loans are not backed by specific collateral. Even though there is no requirement for physical collateral, the majority of unsecured loans are backed by a personal guarantee.
What will I do if I am unable to repay the loan?
If you’re unable to repay your business loan, liquidating your business assets is the most feasible option. However, a lender might go for restructuring the loan or even suggest debt consolidation to help you repay the loan.
How do financial institutions decide to give business loans?
After an applicant applies for a business plan, financial institutions evaluate your business references, company reputation, company debt repayment history, the income and cash flow, and many more. However, every financial institution has its own parameters to determine whether to approve or deny the loan.