There is a great deal of optimism that characterizes the moment someone starts their own business. In fact, there sort of has to be: In order to start a new business, someone has to be genuinely confident that their product or service is better, that they can convince customers of this, and that banks will be likely to understand their unique view of the marketplace. Confidence, though, is something that almost immediately takes a hit if the business’ financing application has been turned down by one or more lenders.
That doesn’t need to be the case, however. In fact, many of the most common reasons for a denial have more to do with the bank’s unique perspective than they do with the validity of the business’ ideas, organization, and plan of attack. If several banks have recently declined to provide any amount of business financing to a small business or startup, it’s worth considering the most common reasons for this type of rejection.
1. Banks are Risk-Averse as a Rule
Most customers think of banks as existing to operate deposit accounts or enable big purchases that cannot be immediately paid for out-of-pocket. Those services are certainly popular, but they’re to the reason the bank opened its doors to the community. Like all businesses, banks exist to make money. One way that banks earn a significant amount of money is by lending funds to business owners and consumers, charging some amount of interest, and using that interest to boost their bottom line.
Banks lose money, conversely, when they offer loans that are not repaid. Those loans then default, and the bank has to write off the remaining balance or suffer the bad publicity associated with quarterly losses. Because some banks really don’t want to do that, they’ll turn away any application that looks even slightly risky. When it comes to risk, few things present more opportunities for financial mishaps than small business lending programs and startup financing.
Small businesses and startups drive the American economy, but they also have a high risk of failing. That’s not to say that many of these businesses aren’t worthy, but it’s simply not possible for all new businesses to experience unparalleled success. Banks know this, and some just don’t want to deal with the consequences of a bad business loan at all.
2. The Business Owner Has Poor Credit
When a business is just starting out, banks will ask for both the business’ federal tax ID number and the Social Security number of the individual who is filing the application for business financing. This is because the bank checks the business’ credit history via the tax ID number, and the individual’s credit history with their personal credit report. If anything negative exists on the consumer’s credit report, banks are likely to take a step back and consider whether or not the loan presents a great deal of risk.
Since banks are risk-averse, as discussed earlier, they’ll likely decline a loan application made by someone who has significant prior credit problems. This includes multiple late payments, especially those made recently, and any collection accounts, charge-offs, or other “key derogatories” reporting by the credit reporting agencies. Though the business itself may be promising, a poor personal credit history can be an anchor that drags down the financing application and gives it no hope of final approval.
3. The Bank Has No Idea What the Business Does, or What it Does It
The nature of the modern small business community is that new ideas are often untested, or at least unheard of, by the people who review lending applications and underwrite small business loans. It’s actually quite possible that a bank simply has no idea what the new business is promising, what it plans to offer, or how the product would possibly make any money. If the bank doesn’t know what they’re lending, why they’re lending it, or how they’ll be repaid over the course of the loan’s term, then they’re certainly going to decline the application.
This is a problem that at least allows some room for explanation or error. Some banks will actually call the applicant to discuss the business and gain additional clarity on the product or service being offered. If the applicant can successfully explain what their new business is going to do, how it is going to make money, and why it’s necessary to do things in a new way, then the bank is far more likely to approve the application. Those who can’t offer a solid explanation, though, will likely receive the dreaded denial feared by all startups and smaller companies.
A “No” is Not Always as Concrete as Many Business Owners Think
Sometimes, a loan denial is just a misunderstanding between the bank’s underwriters and the business applying for a loan. In other cases, the loan is denied largely due to the bank’s own risk-averse lending activities. Either way, business owners should keep in mind that their good ideas are still worthwhile, even if the bank’s lending process seems to indicate otherwise.
