For entrepreneurs, oftentimes coming up with the ideas to launch and grow their business is the easy part. It's finding the money to make it happen that’s difficult. For many small business owners, obtaining a loan from a bank or traditional lender is seemingly impossible, leaving them scrambling to find the infusion of capital they need. Luckily, not getting a business loan doesn't have to spell an end to your business. Here's what to do if you can't get a business loan, and why being turned away isn't always the end of the world.
Common reasons to be denied a small business loan
Before delving into alternative means of raising cash for your business, it's worthwhile to explore exactly why you were turned down for a business loan in the first place. While many entrepreneurs may throw up their hands and give up after being denied a loan, others realize the problem that prevented them from gaining access to a line of credit may be solvable later on down the line. If you don't know why your business was rejected, you can't hope to strengthen your weak points and return later.
Lenders look at several factors when determining if you and your business are worthy of a small business loan. The data is used to paint a picture of your creditworthiness and ability to pay back the money borrowed. Lenders don't want to take on too much risk. So if they feel the risk is too great, they will reject your loan application. The reasons can vary from one lender to the next, but these are some common reasons for a loan rejection:
- Poor credit score: Your personal and business credit scores have a direct impact on loan approvals. The lower your credit score, the more difficult it is to obtain funding. Some lenders work with small business owners who have bad credit. However, they often charge a high interest rate.
- Lack of collateral: Many lenders want to see that you have skin in the game and therefore require business or personal collateral. That could include paper assets, such as stocks and bonds, or property assets, including buildings, equipment and vehicles. If you don't have enough collateral to back the loan, you could be turned down.
- Too much debt: Lenders look at your debt-to-income ratio to determine your creditworthiness. Lenders want the ratio to be In the 30% range, but some will go as high as 40%. If you were turned down because of your debt-to-income ratio, pay down your debt and reapply.
- Not enough cash: To lower the risk of defaulting on your small business loan, lenders typically want to see enough cash in the bank to cover several months of expenses. It could be anywhere from three to six months depending on your lender.
- Not enough years in business: To be eligible for a business loan, many lenders require to be in operation for a set amount of time. For some lenders, it's three months, while for others it may be two years. They want to ensure you won't borrow money and then go out of business three months later.
How to improve your chances of landing a bank loan
To increase your odds of getting a bank loan, you have to improve how you look in the eyes of the lender. That isn't too hard to accomplish if you are disciplined, cost-conscious and willing to sacrifice.
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1. Improve your credit score.
To get a bank loan, you typically need a credit score of at least 680. If yours is lower than that, work to improve it. That means paying bills on time, reducing debt outstanding and not opening new lines of credit. The longer you do that, the more your credit score will improve. It may take a few months or longer, but hopefully, you'll be in a better financial position to get a loan.
2. Bolster your cash flow.
One of the most important things to understand is that healthy cash flow is essential to attain a line of credit. After all, those lending you vast sums of money need to have some reassurance of a return on their risky investment. Demonstrating that you're capable of bolstering your cash flow ahead of receiving an influx of capital is the only surefire way for any business owner to prove to potential investors that they have the capacity to take a loan and turn it into long-term profitability for everyone involved.
So how do you go about bolstering your business's cash flow? First and foremost, cut down on any preexisting debt you have. Few creditors will be willing to give your company the money it needs to survive if you're just going to use it to pay off debts to other investors. Learning how to properly manage and increase your small business's cash flow is essential to long-term economic success in a competitive marketplace.
In that vein, you should ask yourself how you intend to cut the fat from your business. Every enterprise has some waste hidden beneath the surface. You may be relying on outdated or inefficient technology, or perhaps your workforce needs some paring down. Whatever it may be, looking at your current business setup and determining ways to cut unnecessary elements from your business's structure will be necessary to get by without a serious business loan to prop you up.
3. Know what it will cost.
Finally, those who shun traditional business loans, or find themselves unable to attain one, need to understand that alternative financing means are alternative for a reason: They often come with exceptionally high costs. If you have to rely on a third-party lender because a bank or other financial operation won't give you the cash you need, it's only natural for them to charge you steep interest rates so they can reap a return on their risky investment. If you fail to factor in the cost of alternative financing from the outset, you may end up digging yourself deeper into a financial hole.
Alternatives to business loans
If a traditional business loan is outside your reach for the foreseeable future, there are other options to get the funding you need. Here are several alternatives to a traditional business loan:
Lines of credit
A line of credit is an agreed-upon amount of money that a lender – usually a bank but also some alternative lenders – extends to a business. You can draw on this line of credit as needed, but you will pay interest on the amount you use until it is paid off. If you qualify for a line of credit, it is a great way to access emergency funds quickly without having to jump through too many hoops.
Short-term loans
A short-term loan is any loan that you are expected to pay back in a year or less. Banks don't usually offer these loans, but they are quite common for alternative lenders. As the name suggests, short-term loans are beneficial when you have to cover a one-time cost or need a small boost to kick your business into gear.
Invoice factoring
Invoice factoring is a type of alternative funding in which a company sells its outstanding invoices to a third party. The invoice factoring company generally pays 85% to 95% of the value of the invoices, giving your business cash fast. The remainder of the original invoice is paid to you once the client pays their invoice, minus a small fee that remains with the factoring company. This type of loan is ideal for businesses that regularly have outstanding invoices straining their cash flow.
Merchant cash advances
A merchant cash advance is money that a lender provides a business upfront in exchange for a percentage of its credit card sales over a certain timeframe. This alternative financing option is ideal for stores that have a high volume of credit card sales each day, such as a restaurant or boutique.
Microloans
A microloan, typically $50,000 or less, is designed to get small business owners on their feet. These loans are generally not available from banks, but alternative lenders provide them to businesses that need to acquire new equipment, open a new location or hire staff.
Equipment financing
As the name suggests, equipment financing loans are used to purchase mission-critical equipment. Unlike with other loans, the equipment itself is collateral, which can lower interest rates. If the equipment is valuable enough, the application approval process may run much more smoothly, because the equipment mitigates the lender's risk.
Crowdsourcing
Crowdsourcing, as the name implies, depends upon sourcing your funds from a large crowd of people. In most cases, it means taking your case directly to the public and reaching out to thousands, or even millions, of people at once by harnessing the power of digital technology.
Social media campaigns and digital marketing efforts have already demonstrated that crowdsourcing can be incredibly effective. The benefits of crowdsourcing are incredibly diverse, such as when NASA relied upon it for idea generation. As a business owner, you'll be interested in the ability of crowdsourcing to drum up huge sums of cash from the popular approval of everyday people who want to see your dreams turn into reality.
Crowdsourcing your business's capital needs will work only if you can persuasively convince a mass audience to get behind your plans. This is why crowdsourcing is particularly popular among startups that have taken to labeling it "peer-to-peer investment," though even well-established business owners can rely upon the method if they know what they're doing.
SBA loans
SBA loans are backed by the U.S. Small Business Administration and offer business borrowers flexible loan sizes, low interest rates and long repayment terms. The SBA doesn't provide loans itself; instead, it guarantees the loans issued by an SBA-preferred lender or financial institution. The three main types of SBA loans are 7(a) loans, SBA microloans and 504 loans.
- 7(a) loans: These are the SBA's primary loans for small businesses. Interest rates vary based on the borrower's credit score. With this loan, you can borrow up to $5 million.
- SBA microloans: These are smaller loans, ranging from $10,000 to $50,000. They are aimed at borrowers who need money to get a business up and running.
- 504 loans: These are long-term, fixed-rate loans that small business owners can use to expand or modernize their operations. They can be used to buy expensive equipment or for real estate. Terms for these loans run from 10 to 25 years.
Risks of digital lending technology
Despite the allure of using digital technology to solve your financial needs, this technology must be wielded carefully and with great caution. The digital world is rife with scandal and opportunities to diminish your brand. For instance, if your crowdsourcing campaign inadvertently reneges on promises made to the funding public that is making your project a reality, you could have a public relations disaster on your hands as angry investors boycott your business. It is critical to consider all of the options available before finalizing your decision on how to fund your business.
This isn't to say that digital technology isn't often a godsend for businesses in need of alternative financing. Online lending has been spiking in popularity recently, so much so that some are beginning to ask whether banks should be worried about this trend. More standard means of raising money, like getting a business credit card, are also rising in popularity as traditional business loans become more difficult to acquire.
We can expect online means of raising money for one's business to keep ticking upward in popularity, especially as more startups join the marketplace. Entrepreneurs and professionals with limited credit histories will find it frustrating, if not downright impossible, to secure a hefty business loan on favorable terms, so the proliferation of digital technology that enables greater peer-to-peer investment should largely be viewed as a boon for everyone in the business community. Still, it's imperative to remember that you must be cautious and meticulous when dealing with digital sources of money so that you don't get burned.
Chris Porteous contributed to the writing and research in this article.