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Why Small Business Loans Are Denied: And What To Do Next

Financing is an essential element to allow small businesses and entrepreneurs to thrive, but small business loans can be hard to come by. Traditional lenders like small banks are dying out and larger banks often refuse to give out loans under $100,000. The approval rate for a business loan was less than 19% from small banks and less than 14% from large banks as of June 2021. As a borrower, being denied business financing can be a crushing experience — but it’s common and far from the end of the road.

Here’s exactly why you might have been denied for your loan and how to bounce back with the funding you need.

The 5 Common Reasons Your Business Loan Was Denied

There are what is known as the “five C’s of lending” — credit, capital, collateral, character, and capacity. Every lender has its own qualifications, but these five items can make or break your application for term loans. Let’s take a look at the most common reasons why you didn’t receive a small business loan.

Credit: You Don’t Have Enough Business Credit

Credit refers to your personal credit and your business credit, and a low credit score can be a dealbreaker. Your credit history highlights your previous success or failure in paying off debts and scores you based on your past actions that appear on your credit report. This score is called your credit score. Your personal credit score often matters as much as your business credit score, especially because many small business owners don’t understand their business credit score. New businesses often struggle with a lack of credit.

Personal credit is scored from 300 (poor credit) to 850 (excellent credit). The FICO Small Business Scoring Service (SBSS) gives a business credit score from 0 to 300. The Small Business Association (SBA) requires a minimum SBSS score of 155 for its most popular SBA loan — the SBA 7(a) loan. However, each lender will have its own specifications.

Capital: You Have More Liabilities Than Assets

Your business capital needs to show that you are earning profits, or at least on your way to being profitable. Thus, if you were denied a loan, you may not have proven that your assets, or the things of value in your company, outweigh your liabilities, or the things holding your company back financially. A lender will want to see that there’s a good balance of assets and liabilities in your company that allows you to stay in the black.

Also, your past earnings or your projected cash flows may have been too low to qualify for the loan.

Collateral: You Don’t Have Enough To Back The Loan

When you apply for a loan, you have to offer enough collateral to back it. Collateral is something of value that you put on the line in case you fall behind in the repayment schedule. For example, you can use your machinery as your collateral for a small business loan for a construction company. Therefore, if you don’t pay off the loan, the lender is allowed to seize your equipment.

Lenders will consider the nature and value of the collateral during the loan approval process. The good news? If your lack of collateral is the only issue with your loan application, it shouldn’t stop you from receiving the loan.

Character: You Look Risky

One consideration that lenders use might surprise you: Your character and reputation, as well as that of your company, any associates, and any guarantors on the loan. Risky character shows itself in a few ways. For one, if you or your partners have a record (say, several felonies), it might be more difficult to obtain a loan.

Another thing that can hurt your small business loan application is a lack of management experience or a business plan. Lenders want to know that you will use their money effectively and for the correct purposes, and a long history as a manager will help them to trust you. Finally, the industry you work in might be considered high risk, like gambling, construction, food, or real estate. Unfortunately, many lenders are unwilling to offer loans to any companies within high-risk industries, so you’ll have to look outside of standard banks for financing.

Capacity: You Don’t Have Enough Cash Flow

Capacity refers to your ability to pay back what you owe. You may have been denied a small business loan because your earnings were lower than your payments would be. Lenders will determine your capacity by looking at your debt-service coverage ratio (DSCR). This ratio determines the cash flow that’s available. It should be more than 1, which shows that you have a positive cash flow. The lowest DSCR a lender is willing to accommodate depends on its specific requirements.

None of these five factors are taken on their own — lenders look at the holistic picture. For example, a bad credit score may not matter if your earnings have been sky-high and your collateral is sufficient.

Ways To Move Forward After Being Denied an SBA Load or Small Business Loan

If you apply for a small business loan but your application is declined, there are several steps you can take. First, you’ll get your loan denial letter from either the SBA, your lender, or an intermediary — which one depends on the loan. The letter may give you an unspecific answer like “doesn’t meet application standards.” However, you can speak to the lender to ask for more details on why your application wasn’t up to snuff. They should be able to offer you information that can help you get approved next time.

Next, investigate your application. Which ones — or ones — of the 5 Cs might have been a red flag for the lender? If you can fix those mistakes within six months, you can request that the lender reconsiders your application so you don’t have to go through the long application process again. If it’s been longer than six months, you’ll have to reapply.

Finally, if you don’t think you’ll be able to fix the issues on your application (like you’re in a high-risk industry or have something on your record), there’s no need to turn to credit cards with their sky-high interest rates. Look for alternatives to small business loans.

What are the best alternatives to small business loans?

Small business loans are far from your only option to receive financing for your business needs. If you need funding quickly, here are several alternative lender options that could work for you.

Invoice Factoring

This financing option allows you to leverage your unpaid invoices for up-front cash in as little as 48 hours. Basically, you sell your unpaid invoices to a factoring company, and they pay you for the invoice — and usually take care of getting your client to pay. This option works well for any company that struggles with credit since your approval is based off the strength of your client’s business, rather than your credit.

Materials Purchasing

If you need cash for essential construction materials, you can turn to materials purchasing. The lender will buy the materials for you and deliver them to the jobsite — and you pay the lender later. This option allows construction companies to take on bigger projects than they can finance with their current cash flows.

Equipment Leasing

If you need to acquire new heavy equipment for your jobsite but can’t afford to buy it outright, equipment leasing can help. It gives you reliable monthly payments and is more affordable than renting equipment. Also, the payments you make on an equipment lease are tax-deductible and will increase your credit score.

Asset-Based Loans

A company with assets like real estate, equipment, or inventory could qualify for an asset-based loan. The basic idea is that you use your assets as collateral for the loan, so if you fail to make payments, your assets can be taken. This option is flexible, fast and can give you access to more funding than many traditional lines of credit.

Work with Cultiva Financial for your alternative financing needs

Lack of cash flow is the reason 82% of small businesses fail, but there’s no need to worry. If you can’t seem to qualify for a small business loan, let Cultiva Financial help with your business funding. We offer several financing options that will help with your cash flow and grow your business. Reach out today to see how we can work together — consider us your small business funding partner.

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