You maybe disappointed if your small business loan has been refused. No-one wants to apply on the grounds of being rejected.
It’s a common occurrence in 2021 for SME’s to be knocked back for finance, we take a look at why your application may have been declined.
Whether your company is a start-up or well-established, there can often be a number of hurdles to jump when it comes to attaining critical business finance.
If your bank or other potential source of finance has refused your application, it could be down to a number of reasons.
Refused a Business Loan
In this guide, we look at why this may have happened and why a business might be refused a loan or other form of bank financing. We will also focus on alternative funding options and advise on the best route to get future business funding.
It is important to understand from the start being turned down for business finance by one or two lenders does not put a ‘STOP’ on future lending.
What to do when your loan was rejected
Katrin Herrling felt she had nowhere to go when, in the midst of the financial crisis, her bank suddenly changed its lending terms. She had inherited a dairy farm and needed support with her cash flow during the four months of the year the cows weren’t producing milk. “Nothing in our position had changed but the banks felt they had to rebuild their balance sheet,” she said. “I didn’t know where to turn.
I knew that just going to another bank where I didn’t have an established relationship wasn’t going to solve the issue. Outside of banks, I had no idea.” We had no idea why our business loan was rejected at all!
Bank referral program
If you have been declined business funding by a bank, the bank has an obligation to offer you an alternative way of sourcing finance via the bank referral program.
This program will include sending you a valid link to an alternative finance provider, these providers will work on your behalf to ensure that they source the finance that is required in order that your business will not stall in its growth period.
Small Business Enterprise & Employment Act 2015
From today, entrepreneurs should not find themselves in Herrling’s position. As part of the Small Business Enterprise and Employment Act 2015, the UK’s nine major banks will be legally required to refer those SMEs they refuse to finance to an alternative provider, under the bank referral scheme.
“It’s the lack of information on what the alternative finance options are that in my mind has held people back from choosing non-bank finance. And that’s exactly what we’re trying to build,” Herrling says.
Applying For Finance
The financial history of your business is the most crucial barometer when it comes to applying for finance. For new businesses with no credit history and trading figures, getting even a small business bank loan is traditionally problematic – and not helped by the financial crisis of 2007/08 and the knock-on effect across the industry as a whole.
Even though there has been a small upturn in small business lending in recent quarters, it is still an application that, more often than not, receives a negative response.
The reason is simple – it all comes down to risk. Wherever possible, lenders want to see – in cold hard figures – that your business has a track record of meeting its liabilities; specifically repaying money that has been lent to the business. Where this financial history does not exist, your business represents sizeable risk to the lender.
For many high street banks, your application will face an automated analysis and be refused for failing the required. Effectively, you’ll be getting a ‘computer says no’ response based on your business’ lack of financial history and the subsequent risk you represent. Banks not only offer business loans but also invoice finance as an alternative.
It’s important to recognise that lenders are not investors. They don’t look at your business plan like a member of Dragon’s Den and decide to stump up capital for an equity share because they feel your business has a good thing going. Instead, they rely on a simple risk-based examination of your company financials to date. Without any kind of financial background to assess, a lender has no way of knowing if your venture will be successful enough to enable your business to repay any money borrowed.
For more established businesses that have demonstrable trading history, attaining critical business finance is generally less of a challenge though banks and other lenders could still decline an application if they feel the loan would represent considerable risk.
However, one key advantage that larger firms have over SMEs is the standard of application. More often than not, an established business will know more about potential finance options and have an internal finance team or a finance director who have the necessary knowledge and support to put together a detailed and credible bank loan application. In many cases, a start-up or relatively small business owner will try to attain finance by themselves without the required experience or expertise to formulate a compelling case.
Reasons why your small business loan was refused:
- Adverse Information – banks and other lenders refuse to provide finance due to the business presenting too much of a risk. The business might have had a CCJ or been served a statutory demand in the past. Alternatively, the business might have a clean credit file but be refused on other criteria such as failing to provide enough detail on the loan application or looking to borrow more than the lender is willing to provide.
- Lack of Security – in many cases, a lender will look to safeguard their money by accepting a form of security such as a personal guarantee. This is where a business owner takes responsibility for the loan, in the event that they will be unable to repay it, by securing it against an asset such as machinery or vehicles (asset-based finance) or even their own residential property (secured lending). A business owner might even ask a friend or family member to act as a ‘guarantor’ for the loan who would, in the event of the business defaulting on the loan, be able to repay the bank on the business owner’s behalf. A lender is far more likely to provide capital if the loan is secured.
- Lack of Service Ability – the bank weighs up the application and feels that the business is unable to service the debt in an appropriate manner; i.e. not able to make regular repayments or agree to a schedule of the lender’s liking. The business may already have an overdraft with the bank which is maxed out and never chipped away at; the bank may see this as a sign that the business represents risk.
- Poor Preparation – hasty or ill-prepared business loan applications will invariably lead to a negative response. For many business owners, it is difficult to understand exactly what a lender needs to see and it would be better to ask an accountant or financial advisor to help prepare the application. If the application excludes crucial information such as accounts, forecasts and a business plan, the lender will waste little time in rejecting it.
- Time Frame – banks traditionally take their time in processing a business loan application. If your business is struggling and requires a quick boost of capital to support company growth, alleviate cash flow problems or ease the threat of financial distress, it may be unfeasible for the bank to provide the finance in the designated time frame
British Business Bank
In 2013, the Department for Business, Innovation and Skills found that half of first time borrower SMEs were rejected for finance, resulting in 37% giving up and canceling their spending plans. The British Business Bank estimates that banks reject 100,000 small businesses each year, representing an estimated shortfall of £4bn in funding.
Herrling says: “If you’ve been in business six months and you ask your bank for an overdraft, they’re not going to give it to you. They want a much longer track record. But just because a bank can’t fund you doesn’t mean your business isn’t a good business or that there isn’t somebody out there willing to offer excellent finance conditions.
There are other options too including the in-vogue ‘crowdfunding’ method which, contrary to popular belief, can be utilised by established businesses and not just start-ups. Crowdfunding can benefit both the borrower and the lender; the business gets an injection of much needed capital (with lenders bidding for the opportunity to invest, which allows the borrower to select the most attractive terms from the auction-style pitches) whilst lenders can earn themselves a stake in a promising business at a time where other investment opportunities are unattractive due to low interest rates.
Conrad Ford, a leading business finance industry, says:
“There are a surprising number of options if you know where to look. Never underestimate the value of an intermediary when looking into alternatives funding options, as there could be several solutions which you might not be aware of. In fact, some funding solutions such as Business Invoice Funding my be better suited to your business needs than the finance you were rejected for in the first place.”
Business loans are just one funding option available to UK based business. Invoice Factoring is another great way to fund a business, should you like to know more, feel free to contact us.