Introduction
For small business owners, securing funding to start or grow a business can be a daunting task. Even with a solid business plan, excellent credit history, and a successful track record, obtaining a business loan can be harder than ever before. Nowadays, lenders have higher expectations, and meeting their criteria has become quite challenging. In this article, we’ll examine the top reasons why getting a business loan can be so hard and offer tips to increase your chances of success.
Top 5 Reasons Why Getting a Business Loan is So Hard Today
The current lending environment has never been more challenging for small business owners. The following five factors are among the top reasons why getting a loan is harder than ever:
1. Stricter Lending Standards
The 2008 financial crisis led to increased regulation of the financial sector and stricter lending standards, making it harder for small businesses to secure loans. Lenders require more documentation, more collateral, and better credit scores to approve loans, even for experienced business owners.
2. Increased Competition
With the rise of online lenders, traditional banks now face more competition than ever. Alternative lending platforms have come with streamlined underwriting processes aimed at providing quick access to funding, making it challenging for traditional banks to remain competitive. That situation has led banks to increase their criteria for qualifying loans, including higher credit scores and more stringent collateral needs.
3. Economic Uncertainty
In today’s economy, macroeconomic factors such as interest rates, country instability, and trade wars can significantly impact the lending environment. During times of economic uncertainty, banks can be more risk-averse, making it more difficult for small businesses to secure loans.
4. Increasing Bank Consolidation
As large banks continue to acquire small banks, community banks are fading away. Consequently, local banks, which historically provided loans to small businesses, have decreased significantly in number.
5. Loan Refusals
Loan declines aren’t the most significant challenge faced by small business owners. Instead, it’s the aftermath of a loan refusal, impacting the owner’s credit score. Even though lenders don’t say whether declined loans end up on an owner’s credit score, they impact their credit score, which can make getting future loans harder.
The Dos and Don’ts When Applying for a Small Business Loan
Given the challenges small business owners face when applying for a loan, it’s essential to have a thorough plan in place. Here are some dos and don’ts that can make all the difference:
Do Your Research
Research is crucial when looking for a lender. Thus, it’s important to identify the best lender, with criteria you meet. For example, an online lender is the best option for a small business owner that needs speedy loan processing, while a traditional bank is the best option for an established small business owner with a long credit history.
Don’t Apply for Too Much Funding
Small business owners often overestimate how much funding they need, leading to loan applications for too large of an amount. Instead, a business owner needs to take inventory of their needs upfront, so they only apply for enough money to consolidate existing debt or support a business’s growth.
Provide a Solid Business Plan
A solid business plan should include a marketing analysis, an operations plan, and a financial plan, all with realistic expectations for the future of the business. When creating a business plan, tailor it to align with the lender’s needs and demonstrate that lending your business money is a low risk.
Understanding Financial Ratios: How They Impact Business Loan Approvals
Financial ratios are familiar to bankers and lenders when evaluating small business loan applications. When used correctly, financial ratios can help lenders consider how much credit to extend to a small business and at what interest rate. Understanding the importance of financial ratios in the loan application process can be a difference-maker when growing your business. Here are a few ratios you should be familiar with:
Debt-to-Equity Ratio
The debt/equity ratio compares a company’s liabilities to its shareholder equity. It’s a great way to measure a firm’s strategy when using leverage to finance growth. A high debt/equity ratio signifies high debt amounts compared to equity and could mean more risk for a lender.
Current Ratio
The current ratio is a measure of a company’s liquidity, typically calculated by dividing a company’s assets by its liabilities. Lenders use the current ratio to analyze if a small business can pay its debts, making it a vital metric to understand when seeking out a loan.
The Role of a Business Plan in Getting Funding for Your Small Business
A well-written business plan demonstrates that your small business is a sound investment for a lender. Here are the critical components for successful business plan:
Market Analysis
Identify the target market, its size, and the business’s competitive position. Demonstrate that the business has fully assessed existing competitors and understands how to set itself apart from them.
Financial Projections
The financial projections you include in your business plan should create a clear picture of where the business is headed. Provide realistic assumptions about business operations to the lender and set out a clear repayment plan.
What Alternative Lending Options Are Available for Businesses with Poor Credit?
Alternative lending options have become very popular over the last few years. Here are a few alternative lending options to explore if you can’t obtain a traditional small business loan:
Crowdfunding
A popular avenue over the last decade is crowdfunding, which involves seeking funding from supporters via a crowdfunding platform. Crowdfunding is an excellent option for small business owners who need a relatively small amount of funding.
Microloans
Microloans are another alternative lending option for small business owners. They’re usually smaller loans, less than $50,000, and are typically provided by nonprofit organizations to disadvantaged sectors of the business population.
Merchant Cash Advances
Merchant cash advances are a cash advance that lenders base on a company’s credit card sales. These types of advances aren’t subject to the same regulations as traditional loans, which creates greater flexibility for both lenders and borrowers.
How to Boost Your Chances of Getting a Business Loan in Today’s Economy
To improve your odds of success when it comes to getting a business loan, consider taking the following steps:
Build Your Credit Score
Building up a credit score is essential for securing a loan, especially as a small business owner. Pay all bills on time, keep personal credit card debt low, and maintain good relationships with creditors.
Networking with Investors
Networking with potential investors can increase your chances of getting the funding you need. Relationships with angel investors, venture capitalists, and other financial sources can open new opportunities for your business and provide access to interesting loan types.
Conclusion
Securing a small business loan can be a complicated process, but with the right preparation, tools, and mindset, it’s one that any entrepreneur can tackle. Keeping the above tips and strategies in mind, small business owners can navigate today’s lending environment to succeed in growing their businesses.
