Why Banks Don’t Lend to Small Businesses | SMB Compass
Ezra Cabrera | May 24, 2020
If you’re looking to start a new business, there’s one thing you need to secure before you open your company – acquire immediate access to working capital. Nowadays, it’s almost impossible for entrepreneurs to fund a small business out of pocket. From purchasing inventory to hiring new employees, along with paying for day-to-day operations, running a small business is no small feat. That’s why a majority of entrepreneurs rely on small business loans to grow and expand their operations.
However, qualifying for small business loans via banks is not as easy as it seems. In fact, it has become increasingly challenging for small businesses to acquire funding from banks. There are different reasons why banks are declining loans from small business owners. Here are the most common ones:
Related: 8 Things You Need to Do Before Applying for Small Business Loans
1. Increased Regulation
After the previous recession, banks became and remain more stringent when it comes to approving business loans. Keep in mind that banks lend money using the people’s deposits, which is why they need to be more cautious. Unfortunately, traditional financial institutions think that SMEs are riskier than larger companies. It’s for this very reason banks naturally think twice before giving credit to small businesses.
2. Type of Business
Nav.com recently discovered that sole proprietors, state-approved businesses, and new companies are more likely to be denied a loan. Furthermore, traditional lenders also reject small businesses based on the industry they’re in.
For traditional lenders such as banks, the smaller the business, the bigger the risk. This applies to newer businesses as well. A study from the Federal Reserve Website says that only 45% of smaller companies are able to successfully obtain financing from banks, while larger firms have a 72% success rate.
Another factor banks consider when assessing loan applications is the company’s customer base. There is a greater chance you’ll be approved for a loan if your industry has a stable customer base. This makes it critical you demonstrate to potential lenders diversity in your client base, which will help you secure the financing you need.
3. Lack of Business History
Banks favor companies with lengthy and significant business history. However, banks don’t just only approve business with a long history; they also look for a certain amount of success and credibility that generally comes after years of operation. Banks need to see a positive track record that details generated profits over a specific amount of time. Without proof, your loan application may be rejected.
4. Poor Credit Rating
Business credit is one of the main factors lenders consider when reviewing a small business loan application. A good credit rating is an indication that you can properly manage both personal and business finances by paying bills on time and avoiding bankruptcy.
On the other hand, having a poor credit rating indicates you are unable to make sound financial decisions for your company. Therefore, making you incapable of meeting financial obligations should you be approved for a small business loan.
Fortunately, there are a few things you can do to improve your credit rating. You can start by paying your bills on time, reviewing your credit report and repairing mistakes that may appear, and keeping your credit card balances under control. It’s important to remember that your personal and business credit rating can affect your chances of securing a business loan.
5. Not Enough Preparation
Many entrepreneurs think they can just walk into a bank, apply for a loan, and get funded the same day. Believe it or not, this is a common misconception among small business owners, which is why so many are not meticulous when it comes to properly prepare their application.
If you’re looking to apply for a bank loan, the Small Business Administration suggests you have a detailed business plan, personal and business credit reports, financial statements and/or projections, along with bank statements. Additionally, be sure to include copies of legal papers such as articles of incorporation, leases, contracts, permits, and other licenses your business needs.
Check Out Other Potential Lenders for Small Business Loans
The five points mentioned above are but a small sampling of why banks don’t lend to small businesses. It’s tough to qualify for a bank loan but it’s definitely worth the effort. To increase your chances for approval, small business owners should accurately demonstrate their current business status, both in the financing, as well as future projections. In other words, you need to show potential lenders that you are financially responsible to take on a small business loan.
If you can’t qualify for bank loans, you may want to check out alternative online lenders. Much like banks, alternative lending companies offer loan programs for small business owners in need of funding. There are numerous options available in the market, so be sure to assess each one to determine the most suitable option for your business.