How To Activity

Get a Bank to Say “Yes” to Your Loan Application

Landing a loan to start or expand a small business is much more difficult today than it was in the past because of stodgy credit markets and upheaval in the banking and financial industries. Entrepreneurs often complain that bankers don’t understand the financial needs they face when starting and operating their businesses. In many instances, however, business owners fail to help themselves when they apply for bank loans. Following are the seven most common reasons bankers reject small business loan applications—and how you can avoid them.

Reason 1. “Our bank doesn’t make

small business loans.”

Cure: Select the right bank.​ Before applying for a bank loan, research banks to find out which ones actively seek the type of loan you need. Some banks don’t make loans of less than $500,000, whereas others focus almost exclusively on small company loans. The SBA’s reports Micro-Business-Friendly Banks in the United States and Small Business Lending in the United States are valuable resources for locating the banks in your area that are most likely to make small business loans. Small, local banks tend to be more receptive to small business loan requests than many large banks, which often rely on formulas and templates to make lending decisions. Other factors that influence the types of loans that banks make include the industry in which the company competes, the company’s geographic location, and the length of time it has been in business. Establishing a relationship with a bank before you need a loan also increases the probability that your loan request will be successful. Once you find the right bank for your business, open an account there, seek a small line of credit, and repay it consistently.

Reason 2. “I don’t know enough

about you or your business.”

Cure: Although a business plan that explains what your company does (or will do) is a good first step, develop a personal relationship with the banker so he or she gets to know you better and hears about your business from your perspective.​ If you already have a physical location for your business, try to get the banker to meet with you there. If not, try to find a neutral location that gets the banker out of his or her office. Make sure you have your elevator pitch honed because it creates the first impression of you and your business. You should be able to describe your business—what it does, sells, or makes and its competitive edge—in just one or two minutes. Your business plan should address why there is an opportunity in the market, your company’s major competition, what it will take to succeed in the market, and how your business will gain a competitive advantage in the market. Keep your plan focused and concise. Do not fill it up with operational details. In addition, be prepared to supply multiple scenarios of your financial projections, business credit references, and a personal credit history.

Reason 3. “You haven’t told me why

you need the money.”

Cure: A solid business plan with clear financial forecasts and budgets will explain how much money you need and how you plan to use it.​ Make sure your request is specific; avoid requests for loans “for working capital.” Don’t make the mistake of answering the question “How much money do you need?” with “How much will you lend me?” Also, don’t just throw out a rough number without any rationale or justification. If a banker thinks you are just guessing on your financing needs, the conversation will be over immediately. Instead, know how much money you need and be able to explain how the money will benefit your business and get it profitable enough to easily repay the

loan. Remember that bankers want to make loans (after all, that’s how they generate a profit), but they want to make loans only to those people they believe will repay them. Their primary responsibility is to protect the money that all of us entrust with them in our checking and savings accounts.

Reason 4. “Your numbers don’t

support your loan request.”

Cure: Include a cash flow forecast in your business plan.​ Bankers analyze a company’s balance sheet and income statement to judge the quality of its assets and its profitability, but they lend primarily on the basis of cash flow. “Can you repay the loan balance?” is the question that most concerns bankers, and they know that repaying a loan requires adequate cash flow. Collateral that backs up the loan is their last form of repayment, so do not stress collateral in your presentation—stress cash flow! If your business does not generate adequate cash flow, don’t expect to get a loan. Prove to the banker that you understand your company’s cash flow and how to manage it properly.

As a measure of a company’s ability to repay a loan, bankers calculate the company’s cash coverage ratio​, which is its net income plus its noncash expenses (such as depreciation and amortization) divided by the annual payments on the proposed loan. They want to see a cash coverage ratio of at least 1.5:1 before granting a loan. In other words, to support $100,000 of loan payments, a company should have net cash flow of at least $150,000.

Reason 5. “You don’t have enough

collateral.”

Cure: Be prepared to pledge your company’s assets—and your personal assets—as collateral for the loan.​ If a company’s cash flow declines to the point that it cannot make loan payments, banks look for other ways to get their money back. To

protect themselves in a worst-case scenario (a business that is unable to repay a loan), bankers want the security of collateral before they make a loan. They will look to your personal assets first through your personal guarantee. They also expect more than $1 in collateral for every $1 of money they lend a business. Banks typically lend 50 to 90 percent of the value of real estate, 50 to 80 percent of the value of accounts receivable, and just 10 to 50 percent of the value of inventory and equipment pledged as collateral.

Reason 6. “Your business does not

support the loan on its own.”

Cure: Be prepared to provide a personal guarantee on the loan.​ This is a given for most small business loans until the company has a history of strong financial performance. By giving a personal guarantee, you’re telling the banker that if your business cannot repay the loan, you will. Many bankers see their small business clients and their companies as one and the same. Even if you choose a form of ownership that provides you with limited personal liability, bankers will ask you to override that protection by personally guaranteeing the loan. Another way to lower the risk of a bank extending a loan to a small company is to secure a loan guarantee through one of the SBA’s programs.

Reason 7: “You don’t have enough

‘skin’ in the game.”

Cure: Increase the amount of money you have invested in the project.​ A few years ago, entrepreneurs were able to get loans for projects by investing as little as 5 to 10 percent of the total amount. Today, depending on the project, bankers expect entrepreneurs to put up at least 20 to 25 percent of the project’s cost—and sometimes much more. Be prepared to use your company’s retained earnings to pay for a significant portion of the cost of a project.

David Pitts, owner of Classic Graphics, a printing company in Charlotte, North Carolina, knows firsthand how the small business lending environment has changed. In the company’s 30-year history, Pitts has relied on many bank loans to finance the company’s growth. Recently, however, securing bank loans has been much more difficult despite Classic Graphics’s rapid growth (from $39 million in sales to $50 million in sales in just one year) and strong financial performance. Securing several loans that ranged from $200,000 to more than $1 million became much more difficult than in the past, says Pitts. Although Pitts took realistic financial projections and a strong business plan to banks, several bankers rejected his loan requests for Classic Graphics. Pitts decided to merge Classic Graphics with a much larger firm in Minneapolis. This merger was one of many in an industry that has been suffering from declining profit margins.

There’s no magic to getting a bank to approve your loan request. The secret is proper preparation and building a solid business plan that helps explain your business model and builds your credibility with the banker as a reliable business owner.

Sources: Based on John Rampton, “8 Reasons Your Business Loan Was Rejected,” Entrepreneur, November 8, 2016, www.entrepreneur.com/article/284810​; Anna Johansson, “5 Tips to Improve Your Odds of Getting a Small Business Loan,” Entrepreneur, ​www.entrepreneur.com/article/289979​; Jim Hammerand and Sam Black, “Shakopee Printer Acquires North Carolina Company,” Minneapolis/St. Paul Business Journal, December 2, 2013, www.bizjournals.com/twincities/news/2013/12/02/imagine-printer-classic-merging.html​; “Five Tips to Increase Your Chances of Getting a Small Business Bank Loan,” American Bankers Association, March 25, 2013, www.aba.com/press/pages/032513TipsForSmallBankLoan.aspx​; Marla Tabaka, “4 Tips for Getting a Business Loan,” Inc., January 21. 2013, ​www.inc.com/marla-tabaka/4-ways-to-get-a-business-loan.html​; Kirsten Valle Pittman, “Small Businesses Ready for Recovery, Lenders Aren’t,” MCT/Joplin Globe, July 18, 2011, www.joplinglobe.com/dailybusiness/x357284366/Smallbusinesses-ready-for-recovery-but-their-lenders-aren-t​; Emily Maltby, “How to Land a Bank Loan, CNNMoney, September 17, 2008, http://money.cnn.com/2008/09/16/smallbusiness/land_a_bank_loan.smb/index.htm​; Jim Melloan, “Do Not Say ‘I Just Want the Money,’” Inc., July 2005, p. 96; Crystal Detamore-Rodman, “Raising Money: Loan Packaging Help,” Entrepreneur, October 2008, p. 56; Kate Lister, “The Numbers That Matter,” Entrepreneur, November 2010, pp. 98–99.