Those of us in the Financial Services industry hear it all the time. Small business owners stressing over the lack of enough capital resources, particularly when it comes to borrowing money. There are many solutions to this problem, which I’ll briefly mention at the end of the article, but I thought it useful for entrepreneurs to understand some of the reasons for lending institutions turning down requests for money, so that they can try to make their businesses attractive to lenders.
Let’s get the most obvious one out of the way first. Banks, being risk averse and regulated, have strict credit requirements for lending. These apply to both your personal and your business credit, usually measured by a credit score. Late payments, high balances relative to your credit limit, lack of any credit history, collection accounts/judgements, excessive inquiries from applying for credit too often, and foreclosures/bankruptcies damage credit scores. If your score falls below the bank’s minimum requirement you will not be approved for a loan.
Banks are regulated. One area regulations address is lending concentration. Banks are not allowed to exceed certain percentages of their total loans for any one individual or entity. Similarly, they monitor loan concentration in asset classes, industries, and loan types (residential mortgages, commercial mortgages, asset based, lines of credit, etc.). Some banks forego certain loan types altogether. If your loan request happens to fall outside of their current parameters/limits they cannot approve it.
There are too many different reasons for this to go into, but if the type of collateral you offer as security for the loan is not currently acceptable to the bank they will not lend. This can change within each bank over time and does vary from bank to bank (more on that in item #4).
Part of this goes back to lending limits, but it also involves risk mitigation and balancing of assets. Banks are continuously monitoring their entire loan portfolio to ensure they comply with federal regulations, are appropriately diversified, and meet internal profitability requirements. That means that adjustments are continually being made by adding or eliminating types of loans they fund. As an example, the bank declines an application because they have too much exposure in that applicant’s industry.
This is normally missed by borrowers. Every loan contract has clauses requiring the borrower to meet certain requirements. Everyone is aware of payment requirements. However, many contracts also contain financial requirements and clauses that forbid certain actions or conditions. An example is maintaining a minimum debt to income ratio. There are many others*. You may have inadvertently violated one of these covenants. That prevents you from any further borrowing and may result in your loan being called.
Banks are a heavily regulated industry. They must be careful to ensure that they are complying as well as being diligent in reducing their risk exposure. They are, after all, responsible for proper care of their customer’s money. This can make it difficult for some businesses to qualify for a loan. The alternative financing industry offers a variety of potential solutions, enabling those businesses to have access to the capital needed. They are usually not regulated so they have more freedom in choosing the type of loans they fund. They also tend to specialize in a certain type of business financing, allowing them to use expertise to customize a loan to a business’s needs.
In short, if your business is not quite ready for bank lending, an alternative financing solution may be the answer.
*more info at https://en.wikipedia.org/wiki/Loan_covenant