5 Common Reasons Small Business Loans Are Denied (and How to Avoid Them)
Loans can be crucial for growing your small business. Discover five common reasons for business loan rejection, and what you can do to avoid these pitfalls.
Obtaining funding is essential to growing your small business. When a business loan request is denied, it can be quite a blow, leaving you searching for other funding sources. The good news is there are simple steps you can take to improve your financial situation and make your business more favorable to lenders. The first place to start is understanding common reasons funding is denied so you can avoid these pitfalls.
The Federal Reserve Bank published a Small Business Credit Survey that offers data on how small firms across the United States obtain and use funding. In a section on financing applications, the survey notes that approval rates on loan, line of credit and cash advance applications declined from 76% in 2020 to 68% in 2021. In this article, we’ll go over some of the common reasons for business loan rejection, and provide insights on what you can do to improve your chances of securing funding.
For additional guidance on your small business loan application, contact a small business banker today.
1. Too much existing debt
Lenders may examine your history of debt to get an indication of your business’s ability to repay the loan. They are not only looking for the amount of debt you have, but the ratio of debt compared to your company’s net income.
>>Related Reading: The 3 Biggest Things Banks Look at When Reviewing Small Business Loan Applications
High levels of debt may result in banks seeing you as a higher-risk borrower. To limit your debt, keep track of your existing loans and lines of credit and ensure that you’re keeping your credit utilization low. In addition, be cautious when taking on new debt and make sure you have a strong enough cash flow to cover monthly payments.
2. Poor credit score
Both your business and personal credit scores can affect whether or not your small business loan is granted. Low credit scores signal to lenders that you may have trouble making payments on time or that you have high levels of outstanding debt.
Your personal credit score is tied to your Social Security number, whereas your business credit score is tied to your Employer Identification Number (EIN). When you apply for a business loan, be aware that we’ll examine your business credit score as well as your personal credit score. Keeping track of two separate scores may sound confusing, but thankfully, improving your business’s credit score is not much different from building your personal credit.
Tips for improving your business credit score
Your business’s credit score is based on activity from your business credit cards and any previous loans you’ve received. Below are some ways you can boost your score:
- Pay off your monthly bills on time. Timely payments signal your potential trustworthiness as a borrower. Paying bills on time also helps you avoid late fees, which can reduce your overall debt.
- Keep your credit utilization low. If you frequently come close to hitting the maximum credit limits on your credit cards, lenders may question your ability to take on more debt. We recommend keeping your credit utilization rate at or below 30%, if possible.
- Avoid applying for multiple lines of credit in a short period of time. Having multiple credit inquiries on your account within a short span of time can negatively affect your credit, as it could be a sign that you’re financially stressed and in drastic need of funding.
- Check your credit score frequently. Regularly checking your business credit score through multiple reporting agencies can help you ensure your rating is correct and no fraudulent activity has affected your score. The most common reporting agencies are Experian, Equifax and TransUnion.
Improving your credit takes time, but following these best practices can help you build your score.. Keep in mind, even if something occurs that results in a ding on your credit score—for example, a late payment or too many hard inquiries—your score will likely bounce back after a few months.
3. Insufficient collateral
Collateral refers to assets you pledge for the life of your loan as a way of reducing the lender’s risk. Depending on the loan, assets used as collateral could include cash, future earnings, equipment or property. In some cases, you may need to pledge personal assets such as your house or your car to secure a loan. Not being able to provide sufficient collateral could be one reason for business loan rejection.
The type of collateral you need in order to obtain a loan for your small business will vary depending on the type of loan and the lender. It’s important to understand the requirements of the business loan you are applying for so you know what to expect in terms of collateral. You’ll want to make sure that you are choosing a loan that meets your needs without running the risk of pledging assets you can’t afford to lose.
If you’re worried about being able to provide enough collateral for a loan, there are other options available. Many business loans don’t require collateral—instead, approval is based on your credit history and financial statements. Our small business banking team is happy to walk you through different types of funding solutions that may be available without collateral.
4. Not enough credit history
Lenders are generally looking for evidence that you’re a responsible borrower who pays back their debt on time, but if your business is newer, it’s possible that you haven’t taken on loans or other lines of credit before. This can be viewed as a red flag because it’s not possible to look back on your payment history.
Establishing credit for your small business
If your small business is brand new, you may be wondering how to establish and build your business credit score. These are some of the first steps you should take to separate your business finances from your personal finances:
- Form a limited liability company (LLC), limited partnership or corporation.
- Obtain a federal Employer Identification Number (EIN).
- Open a business checking account with your legal business name.
- Set up a dedicated business phone line using your business name.
These steps will help you start building your credit as a business, which will help lenders like Cadence Bank evaluate your business’s financial standing and connect you with the funding you need.
5. Poor business performance
Another common reason for business loan rejection is poor business performance. Lenders may be wary of giving a loan to businesses with low revenue because of concerns about the business’s ability to pay back the loan. Oftentimes, the fix for this type of small business loan denial comes back to limiting your debt and strengthening your business’s cash flow. Make sure you’ve provided up-to-date financial statements so the lending decision isn’t skewed by inaccurate information.
You might also consider being flexible in regards to the amount of money you’re requesting. In some cases, you may be approved for a smaller amount than you requested. While this can be disappointing at first, it could be enough to meet your business’s needs without putting you under excessive financial stress, in terms of the amount of debt you have to pay back.
>>Related Reading: 6 Tips to Improve Your Odds of Getting a Small Business Loan
If you were denied a business loan and think it may have something to do with your business’s performance, talk to your banker and ask them if there’s anything you can do to improve your application. Establishing a relationship with a small business banker can go a long way. As your banker gets to know your business and its history, they can provide guidance on what types of funding best suit the needs and goals of your business.
Learn more about Cadence Bank’s business loan services
We know that getting a small business loan denied can be discouraging, which is why we’re happy to walk businesses through the different ways they can strengthen their loan applications. At Cadence Bank, we offer a variety of business loans and lines of credit that can help you achieve your goals. To learn more about the options available to your business, contact one of our small business bankers today.
This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.