“We keep getting turned down for loans, but we don’t know why. The bank gave us nothing further to go on.”
I hear laments like this all the time from potential loan applicants who tell me they don’t know why a previous application at another institution– usually a large bank – was rejected.
The truth is that banks are looking for ways to approve loan applications. But big banks are both more risk-averse than community banks and deal with a higher volume of loan applications, so it doesn’t surprise me that rejected applicants are often left in the dark about the reasons.
So here’s a guide to some of the top reasons banks deny business loan applications – and one pretty effortless thing you can do to improve your chances of getting a “yes.”
Insufficient Operating History
With community banks approving just over 50 percent of business loan requests (and big banks approving only 21 percent), a clean balance sheet isn’t enough to land a loan these days. Banks are looking for businesses with operating histories of at least three years, a sufficient level of success and credibility, and sustained profitability. If you don’t have a track record, you’ll have a hard time getting a loan.
Inadequate Management Team
Business loans are investments, and investments are made as much in the people at the top as they are in the business itself. How long has the CEO been in his or her role at the company? What is his or her prior experience? What about the CFO and other top managers?
Of course, there are some very successful businesses being run by their original founders, who may not have had previous senior management experience. But for every Mark Zuckerberg out there, there are many businesses that suffer, and even fail, when they outgrow the experience and acumen of their founders.
Banks are also looking to see if there’s a succession plan. Many businesses have floundered after a key executive or founder unexpectedly dies or becomes incapacitated, so we naturally want to know what your plan is in such a case – and I’m surprised by how many businesses I see that don’t have any succession plan at all.
Too Much Customer Concentration
Just as investors are well advised to maintain a diverse portfolio, businesses are healthier when their revenue comes from many different sources. It may feel great to land that “whale” of a client, but when your livelihood depends on too few relationships, you’re at risk. How much concentration is too much? That depends on the business – and it’s a great subject for a conversation with your bank’s representative.
Insufficient Personal Guarantees
If there’s a hiccup in the business, can the people guaranteeing the loan fill the gap until the business gets back on its feet or rights itself? Banks pull personal credit scores, so it’s important to keep that number in line. We also review your personal financial statements and about three years of tax returns because we want to be sure you have enough assets and liquidity to meet personal expenses – and the funds to help your business out if it needs it.
Of course, a bad balance sheet will kill your chance of landing a loan quicker than anything else. I could easily spend this entire blog post going over the financial reasons, beyond those already discussed, that a loan might be rejected. But if you own a business, then you probably already know them:
• Lack of consistent cash flow
• Insufficient collateral
• Lack of working capital
• Weak equity position
• Too much existing debt
What some business owners don’t know is how much debt is too much. The rough benchmark almost every bank uses is three times your cash flow. That’s 3 × (net income + interest expense + depreciation - withdrawals).
The One Thing Every Loan Applicant Should Do
I always recommend that business owners sit down in person with a bank representative in advance of applying for a loan for a candid conversation. The subject: whether you’re a good candidate. If you are, he or she will help you navigate the process and advise you on ways to boost your chances of approval.
Then, when you do apply for the loan, have everything in order. Banks usually look for three years of business and personal tax returns and financial statements, accounts receivable and payable. That will expedite the time it takes to get a decision; here at 1st Mariner, for example, we can make a decision very quickly after receiving everything we need.
Like I said up top, banks want to make loans. The surest path to getting there is to cultivate a relationship with your bank.
If you have any questions, we’re here to answer them.