In an ideal world, the route to business finance would be smooth. You would find what loan you want, apply for it, get accepted and then be given the capital you need to pursue your ambitions.
In reality, it’s rarely this simple. Even once you have pinpointed a suitable loan for your company, there are no guarantees that you will be accepted. Data suggests around 50% of loans made by small and medium-sized enterprises are rejected in the UK – and nobody wants to be part of that figure.
When attempting to secure funding, you need to do everything you can to maximise your chances of success. This means understanding the common pitfalls that see businesses rejected for external finance and using them to strengthen your application.
Below, we have detailed the top reasons that your business loan may be rejected and how to avoid them, so you experience fewer obstacles when raising capital for your goals.
- Your credit score is low
- You have no collateral
- It’s not clear what you’re using the money for
- You’re ‘high risk’
- You’re asking for too much
- You haven’t worked out the financials
- You’re new to the industry
Your credit score is low
Your credit score acts as a measurement of your financial history. If you’ve always kept on top of your finances, you’re more likely to reach that perfect 100 score. If you have defaulted on payments, paid late or experienced debt, it could leave a dent.
With credit scores seen as a gauge of how reliable a person is when it comes to debt, it’s no surprise that many banks and lenders check this before they decide whether to lend to a business. If you have a low credit score, it could serve as a deterrent and lead to rejection.
Before making an application, you should review your credit score to determine how healthy it is. Many bodies will offer a report on this, and some may even provide it for free. If there’s room for improvement, there are fixes you can implement. These include settling debt quickly, making payments on time (even if you haven’t historically) and avoiding closing accounts.
If you’re a newly established enterprise, you may have no credit history to speak of. In this case, you will need to build your score over time by using credit in your business and ensure debt levels are kept to a minimum. The more often you make timely payments, the more your credit score will grow – and your eligibility for loans will increase as a result.
You have no collateral
Many banks and lenders rely on collateral as security against the loans they offer out. This means that, even if someone defaults on their repayments, there are alternative methods of getting back the money owed.
Typical forms of collateral include assets, such as property, vehicles and high-value equipment. Whether or not you have any assets to use, you may be asked for a personal guarantee – but these can be risky, and many people do not wish to volunteer their own wealth as a backup if their business can’t make payment. If you consider a personal guarantee, it’s essential to be aware of the implications and protect yourself with insurance.
If you don’t want to give a personal guarantee and don’t have any other assets to secure against, it isn’t necessarily the end of the road. While traditional lenders will want security, there are unsecured loans on the market which you can obtain without collateral. You may have to compensate for higher interest rates to mitigate the risk to the lender, however.
It’s not clear what you’re using the money for
When you are applying for a loan, most lenders will want to know what it is for. In some cases, there may be restrictions on how funding can be used, which you need to prove you are abiding by.
Be clear about why you are seeking finance when filling out your application. There may be relevant sections that specifically ask for this detail. You should aim to be as detailed and truthful here, as it could backfire if you are found to be lying about your need for funding.
By showing how the money will be used, will help to convince lenders that there is a reasonable rationale behind your application and that you won’t be burning money that they will never see again.
You’re ‘high risk’
When a lender agrees to loan you money, they are doing so under the risk that you might, for whatever reason, not repay them. As such, they spend a great deal of time undertaking checks to determine how likely it is that this will happen. If they see you as high risk (i.e. high likelihood of default), they will either not offer you a loan or offer it on very penal terms.
Many factors determine your risk level, including your credit score, trading history, amount of funding required, amount of collateral and so on. Sometimes, even if you have every intention of paying back your loan, a bank might look at you and decide your proposition is just too risky. It can seem unfair, but it is common, particularly for risk-averse lenders such as banks.
The best way to assuage any fears about your risk is to ensure you have a strong application, good financial performance and a positive balance sheet. You can also focus on building an excellent credit score.
If you still experience barriers, your next option is to seek lenders who are more open to risk, such as those offering alternative finance. They may provide better flexibility in who they are willing to loan to, even if there are risk factors in your business. You may find interest rates are higher and loan sizes smaller as a result, but it could be the necessary price to pay to get capital for your ambitions.
You’re asking for too much
Before approaching a lender, you should estimate how much money you want to take out as a loan. You should calculate this figure with careful consideration of the expenses you need to absorb to fulfil your objectives, and you may need to showcase this to the lender.
If it’s perceived that you’re asking for too much, it’s likely to draw scepticism from lenders. Asking for an overly high figure could signal that you don’t understand your finances, which could bring into question your ability to repay, or that you’re using the money for unnecessary purposes.
The amount a lender will give you is dependent on your risk level and how much they think you will be able to repay. So, if you’re a high-risk business with no security to offer, sum that you are able to borrow is likely to be low. The bigger the loan, the higher your repayments will be, which can strain cash flow and make you more likely to default.
To avoid this, you need to be realistic when working out how much money you need. You need to find the balance between how much you want and how much a bank is willing to give you. By doing this, you should settle on a figure that suits all parties. There’s always the option to utilise other forms of finance.
You haven’t worked out the financials
To secure funding, you need to convince lenders of your ability to manage your business finance. If you’re financially responsible, it should indicate that you will use any loans sensibly and make payments on time.
Managing finance particularly matters if you are juggling multiple commitments, such as regular expenses (supplies, wages and other bills) or additional loan repayments. The lender wants to be sure you will be able to meet your repayment schedule as well as your other commitments.
When providing financial information as part of your application, you need to make sure everything adds up. This means being honest and accurate in the information you give and understanding the role that finance will play in the broader operation of your enterprise. This will show that you run your business smoothly, maintain good cash flow and generate profits. On the other hand, if you’re not on top of your finance, it could signal that you may run into cashflow issues and fall behind on your repayments – and that’s a big red flag for a lender.
You’re new to the industry
Unfortunately, new businesses are generally less likely to pursue lending. A study from the British Business Bank in 2018 found that only 37% of SMEs utilise external finance.
There are many reasons why new businesses may face challenges when applying for funding. They may have a low net worth or few assets to use as collateral. They may have a poor trading history or low credit score. All of these can put risk-averse lenders off.
If you are an SME and experience resistance from lenders, it doesn’t mean all hope is lost. Instead, it may be worth considering alternative lender or different types of lending mechanisms.
If you are a start-up, there are a number of solutions in the market from a range of providers.
Get advice
Securing external finance is an important stepping stone for any business. However, with many facing rejection or even put off applying due to the fear of rejection, it can be hard to get the funding you need.
Understanding the common reasons behind loan applications being turned down can help you refine your approach and increase your chances of success. In some cases, it is simply a case of trying again until you find the perfect lender.
If you need support in finding a business loan that suits your needs or crafting a fool-proof application, we can help.
Our advisors have worked with hundreds of businesses to obtain the loan capital they need to reach their goals. We can discuss your requirements and put together a plan to obtain your funding from a range of suitable options depending on your particular circumstances.