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8 Factors That Keep You From Getting a Small Business Loan

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goodluz/Shutterstock

Business loans can be essential when you're launching a startup or looking for additional funding to expand an existing company. The funds are used to secure inventory, purchase equipment, rent operational space, hire employees or cover a host of other expenses.

According to a report by the National Small Business Association, in 2017 nearly three-quarters of small businesses were able to access the funding they needed to grow. However, financing remained a challenge for 27% of U.S. businesses. According to the NSBA report, businesses that were unable to secure capital had to take difficult actions, including reducing the number of employees and deciding not to expand operations, finance increased sales, or increase inventory to meet demands.  

Since loans can be so critical to your business success, it is worth learning the most common barriers borrowers face when looking to secure a business loan. Once you learn about these roadblocks, you can take the steps to circumvent them and find the right type of loan and lender for you.

Credit reports are one tool lenders use to determine a borrower's credibility. If your credit report shows a lack of past diligence in paying back debts, you might be rejected when applying for a loan.

Paul Steck, CEO of Spread Bagelry, has worked with hundreds of small business franchisees, many of whom have bad personal credit as a result of illness, divorce or other extenuating circumstances.

"Sometimes, very good people, for reasons beyond their control, have credit issues," Steck said, "and, unfortunately, that's a real barrier to entry in the world of small business."

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It is difficult to qualify for a small business loan with a credit score of less than 700. 

"A score of 720 seems to be the magic number, above which your likelihood increases dramatically and below which it decreases dramatically," said Brian Cairns, founder of ProStrategix Consulting, which provides a host of services to startups and small businesses.

If your score is under 700, Cairns advises focusing on fixing it if you can. Begin by checking your personal and business credit scores to ensure they are accurate. If you find any errors, correct them before beginning the loan application process. You can order a free personal credit report yearly from each of the three credit-reporting companies on AnnualCreditReport.com. Credit-reporting agencies Dun & Bradstreet, Equifax and Experian deal only with business credit.

Additionally, you should build a strong personal credit score and drive down any debt prior to applying for a business loan.

"The better your personal finances are upfront, the more likely you are to be approved for a good loan option," said Jared Weitz, CEO and founder of United Capital Source, a lender for small and midsize businesses.  

"Most loans require some form of down payment, and this is typically varied based upon the borrower's financial history and the collateral put up for the loan," Weitz added. "Based on this, most loans range from zero to 20% down payment for the loan."  

If your credit is still far from ideal after you take these steps, consider nontraditional financing options – which tend to place less emphasis on credit scores – before giving up on getting a loan. 

"Angel investors, or individuals interesting in backing the business in exchange for a share in the eventual revenue, can be a way to help get your business off the ground," said financial attorney Leslie Tayne of Tayne Law Group.

Cash flow – a measure of how much cash you have on hand to pay back a loan – is usually the first thing lenders look at when gauging the health of your business. Insufficient cash flow is a flaw that most lenders can't afford to overlook. Therefore, it's the first thing business owners should consider when determining if they can afford a loan.

"Really thinking through that cash flow equation is like preventative medicine for your business," said Jay DesMarteau, head of regional commercial specialty segments for TD Bank. "You can either wait until [your business] gets sick, or you can do things to prevent it from getting sick."

One of the preventative measures DesMarteau recommends is to calculate cash flow at least quarterly. If business owners take that step, they may be able to optimize their cash flow before approaching potential lenders.

To figure out how large of a loan payment you can afford, divide your net operating income by your total annual debt to calculate your debt service coverage ratio. You will have a 1.0 ratio if your cash flow is equal to your monthly loan payment. Though a 1.0 ratio is acceptable, lenders prefer a ratio of 1.35, which demonstrates you have a buffer built into your finances.

"If you're not sure of your current financial position or capacity, sit down with a financial planner to help you gain the perspective you need and create an action plan to address any lacking areas," said Chad Rixse, director of financial planning and wealth advisor at Forefront Wealth Partners.  

Having a plan and sticking to it is much more attractive than spontaneity in the finance world. 

"Lenders want to see that you have a well-thought-out plan for your business," Tayne said. "Applying for a loan with no business plan or with a half-baked plan will not bode well."

However, it is not uncommon for very small businesses not to have a formal business plan – or any plan at all.

The only way to remedy this situation is to put in the time and work to develop a comprehensive business plan before ever walking into a lender's office.

"If you don't have a documented plan in place with financial information and projections, your chances of receiving the big loan you want will dwindle," said Weitz.

A standard business plan includes a summary of your company, market, products and financials. If you are unsure if your plan is persuasive enough to sway the lender, consider seeking the advice of a business plan expert who can review it and offer feedback.

You should also be prepared to explain your plan for the money you want to borrow. "Applicants can position themselves much better by being able to call out exactly what they need and what they need it for," said Bernardo Martinez, U.S. managing director for Funding Circle, a small business loans platform.

"Instead of asking for $100,000 in working capital, if an applicant says they need $33,000 for inventory in advance of their busy season, $37,000 for new hires, $20,000 for upgrades to their store and $10,000 for advertising, we are much more confident in their ability to effectively deploy the funds," Martinez added.

At the bare minimum, loan applicants should be prepared to explain why they want a loan and how they plan to repay it.

Some business owners assume they can cover all their bases by applying for multiple loans at one time. This way, they can pick and choose from a range of potential offers. However, opening too many loan applications at once can be a red flag for credit bureaus.

When it comes to approaching potential lenders, business owners should have their act together. That means having all the paperwork necessary for your loan application on hand.

"One of the things that can be a problem when applying for a loan is if [business owners] don't have the documentation that the bank will require," Steck said. 

Obligatory documentation often includes a detailed business plan and collateral; extensive financial records such as income tax returns, personal and business bank statements, loan history, and a balance sheet; and legal paperwork, such as franchise agreements, business licenses and registrations.

There are many resources that business owners can refer to when putting together their loan applications. The Small Business Administration, for example, provides a highly detailed loan application checklist for borrowers. Using these resources can decrease your likelihood of coming across as disorganized or unprepared. 

Careless errors will land your application in the rejected pile. "Filling out the application incorrectly or omitting information is another common mistake that can lead to your application getting denied," Tayne said.

Tayne also pointed out that sloppy bookkeeping and inconsistent business practices, such as not filing tax returns or mixing business and personal bills together, can prevent you from getting financing. She advises taking the time to gather all the necessary information, fill out the forms completely, and read over your application before submitting.

When it comes to making financial decisions for your business, lenders want to see that you've sought guidance from knowledgeable advisors.

Accountants can be an important source of advice for small business owners, according to Stephen Sheinbaum, CEO of Circadian Funding, which helps small and midsize businesses obtain working capital. He has collaborated with the National Directory of Certified Public Accountants in the past.

"But there are many other places to find good people to talk to, such as the Service Corps of Retired Executives (SCORE), a free mentoring service that is supported by the Small Business Administration," he said.

According to Sheinbaum, SCORE connects you with retired businesspeople with experience in your market. "This is important because they will know about the kind of capital that is most important to people within your industry."

He also recommends that business owners get financial advice from business networking groups and conduct research on the websites of the leading alternative funders, since many have detailed resource sections for small businesses about the many kinds of available capital and the best ways to prepare for funding.

Other resources that provide counseling, advice and financial assistance for new businesses include the regional and local offices of Veterans' Business Outreach Centers and Women's Business Centers.

Finding a lender can feel so daunting that it might be tempting to sign up with the first one that comes along. But blindly pursuing one loan provider without exploring your other options can be a mistake. Business owners should take the time to research a range of traditional and alternative lenders suited to them. 

Financial institutions in the community where you plan to do business are an ideal place to start looking for a business loan, according to Logan Allec, a CPA and founder of the personal finance site Money Done Right. "Start with a community bank or credit union that is more invested locally, as they may have certain programs to be able to work with new local businesses."

The U.S. Small Business Administration also provides federal backing for some businesses to receive loans through partner financial institutions. "This can be an excellent avenue to explore if you are having trouble finding a traditional lender for your business," Allec said. 

Other alternatives to traditional lenders include online lending platforms, peer-to-peer lending sites, and tapping into your network of friends and relatives. If you pursue this last option, Allec suggests working up an official, notarized agreement to avoid any misunderstandings or conflicts down the road between all the involved parties. 

When shopping around, you can also request that each lender help you calculate the annual percentage rate (APR) of their loan offer.

"The APR tells you the true cost per year of borrowing money; it takes into account your interest rate plus any additional fees and charges," Martinez said. "This will help you make an apples-to-apples comparison of different loan offers."

So much of the application process for a business loan is methodical, directed by the orderly presentation of concrete documentation, that it's easy to forget there is an innately emotional component to this process as well. Too many business owners simply don't demonstrate why they, rather than someone else, are a good candidate for a loan. They approach lenders with an apathetic attitude, according to Steck.

In addition to making a sound business case for why you should qualify for a loan, you need to exude enthusiasm and faith in your venture to draw in the lender and makes them a believer. To do this, you must tell a story about your business that the lender finds compelling.

"'I'm going to do this, and I'm going to be the best in the whole wide world' – you have to go into it with that sort of mentality, and a lot of [potential borrowers] don't do that," Steck said.

Weitz echoed this sentiment. "The more prepared, serious and passionate you appear about your business, the more trust a lender will have with approving you for the loan."

Additional reporting by Elizabeth Peterson. Some source interviews were conducted for a previous version of this article.

Paula Fernandes

Paula is a New Jersey-based writer with a bachelor's degree in English and a master's degree in education. She spent nearly a decade working in education, primarily as the director of a college's service-learning and community outreach center. Her prior experience includes stints in corporate communications, publishing, and public relations for nonprofits. Reach her at fernandes.write@gmail.com.