Challenges Small Businesses Face Getting Bank Loans
Small businesses often face numerous challenges on their entrepreneurial journey, of which, financial and operational issues are the primary ones.
The major challenges small entrepreneurs face when they plan to expand their businesses are:
Lack of Collateral:
Often, small businesses do not have collateral, a personal or business property which can be either properties or equipment. Banks and certain Small Business Administration (SBA) loans require collateral to approve business loans as it acts as a secondary form of loan repayment, in case of default. Small entrepreneurs face a lot of problems in getting loans approved by traditional financers like banks as they don’t have a business infrastructure and mostly use their personal property like homes as collateral.
No track record
One of the primary reasons small businesses are unable to get loans approved is the lack of an extensive track record, which most conventional lenders ask for, to assess their creditworthiness. Banks often demand several years of business transaction data to approve a loan.
Conventional financing institutions like banks strictly consider the credit lines and past payment history of the business credit reports to understand if the borrower is capable of repaying the amount and approves a loan accordingly. As small entrepreneurs are mostly dependent on their personal credit reports due to the lack of adequate business credit history, they find it quite difficult to borrow funds from banks.
Besides credit history, a lender also audits a business’ income to determine its capability to repay the amount. Businesses that are strained with expenses but do not have steady income generally have a harder time proving their creditworthiness to banks.
Inadequate capital investment
Financers or lenders often consider applicants who have a sufficient capital amount invested in their businesses, but are still capable of financing their debt. Entrepreneurs who haven’t invested money from their own pockets and are solely dependent on external funding often get a negative impression and have a lesser chance of getting their loans approved by banks.
Tips to overcome the challenges:
Cash flow management
An entrepreneur must be familiar with cash flow metrics to evaluate the cash flow of their businesses. Assessing the accurate cash flow not only helps one to understand the strength of a business but also discloses its capability of servicing debt.
Increase income and decrease debt
The debt-to-income ratio of a business determines its eligibility to get a loan sanctioned. It shows whether the entrepreneur can bring in cash flow to repay a debt. One needs to increase the gross monthly income and the amount paid in debt every month to prove creditworthiness.
Get the documents ready
Those looking for a loan should have an elaborate business plan, tax returns for the past few years, balance sheets and other business documents to speed up the loan approval process.
Build business credit
It is very important to build a business’ credit history as it opens numerous doors for the entrepreneur to choose from and select one as per his/her convenience. For example, the SBA loan program-7(a) requires a FICO SBSS score for the financers to approve loans to businesses. It is suggested to improve the business credit before applying for a loan. One can evaluate the credit by getting a free copy of the personal credit reports from credit bureaus. Also, negative records like late payments need to be resolved to increase the chance of getting loans approved.
Try to make a moderate investment
Lenders often consider the debt-to-equity ratio to assess the amount an entrepreneur is seeking and how much he/she has already invested in the business. A ratio of 1-1.5 is ideal to prove to the lenders that a reasonable amount is already invested in the business and the entrepreneur is also capable of repaying a debt. Once the business grows and sales increase, one should add assets to reinvest a portion of the income and repay debts to enhance the equity and maintain a considerable debt-to-income ratio.