Why is it so hard for small businesses to get loans?

So you walk to the bank, fill out a few papers, and a short time later, walk back home with a neat small business loan in your pocket.

And then your alarm chimes. You sit up in bed and realize it was just a dream.

That’s OK; dreams can indeed come true. Unfortunately, this isn’t usually one of them. Because even if you end up among the few small business owners whose loan application is approved, the process isn’t going to be this simple. Or fast. 

But then again, surveys such as this one have found that 82% of small business loan applications are denied. Given that, the whole thing seems quite unlikely to happen at all.

Does your small business qualify for a loan?

In most cases, it does. 

So, why are most small business loan requests denied? The answer is even more important than you’d think. Sure, it’s reassuring to wallow in self-pity for a bit and feel like the whole world is against you. But, knowing the reasons can also help you perfect your loan application, or – even better – discover a more attainable source of funding that will help you reach your goal.

Same process, a lot less to gain for banks

You’ll learn a lot about how small business loans work if you look at the terms from the lender’s point of view. 

Regardless of the amount a potential borrower is applying for, banks have to go through the same process of evaluation, verification, risk assessment, regulation compliance, etc. But while the process is the same, the return on investment (ROI) is not. It’s really, really not.

Now, would it make sense for a bank to do the same amount of work for a business loan of $250,000 as for one of $2,500,000? Unfortunately, banks are out to make a profit and more often than not, it’s just not worth it for them to go through all the hassle for such a limited return.

On loans that do get approved, this is exactly the reason why small business loan rates may be higher than those of big corporations.

No collateral

Many small businesses, especially those just starting out, lack the necessary collateral to get a business loan. Simply put, you don’t have enough tangible assets (building, property, equipment, vehicles, etc.) that the bank could put against your loan as insurance against the possibility of non-payment.

But this is a typical Catch-22: without money, you can’t purchase tangible assets to put up as collateral for a loan application.

Depending on the size of the loan, you may consider offering your family’s personal assets (home, parents’ car, etc.) as collateral. Make sure you’re comfortable with this option though. It’s risky. It goes without saying that losing your home is an extremely serious consequence if your small business fails to live up to your expectations.

No (credit) history

This is another Catch-22 scenario that’s especially hard on small businesses. Some say it’s even worse than applying for business loans with bad credit. If you’re just starting out, how can you prove you’re trustworthy? But if you don’t get startup funding in the first place, can you start out at all?

It’s like trying to land your first job, but you need 5 years experience to qualify.

Again, you can show your personal credit history to vouch for your trustworthiness. Also, to prove how serious you are, you’ll have to show your would-be creditors how you’ll use their money to make your startup a success. 

Create a sound business plan that reassures nervous investors of the ROI. It doesn’t hurt to mention a few details about the processes you’re planning to run your startup with. For example, showing how you’ll save money on wire transfers, or by providing pay links to customers for faster payments, will show your innovative spirit and business mindset.

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How to get a small business loan

Despite the problems listed above, it’s not impossible to get a small business loan. Especially if you’re well prepared and know where to apply.

Be prepared

Look carefully at the requirements of lenders and make sure you fulfill them all before handing in your application. Have your business plan, small business accounting sheet, bank statements, and any other document ready to help make your case and convince the lender of your intentions.

Make sure you don’t send in too many applications at once. While knocking on more than one door may help increase your chances of success, applying for several loans at once can raise a red flag with credit bureaus.

Alternate lenders

Why do you want a bank loan in the first place? Do you enjoy having your business statements dissected by bank officials or do you simply need money? In the latter case, consider alternate lenders. 

Gone are the days when banks used to monopolize money. Today, financial technology (fintech) allows people and businesses to turn to alternate providers when it comes to various processes (for example, global transfers) or a source of credit.

Have you tried invoice discounting and factoring? Or crowdfunding? Have you looked up angel investors in your industry? Are there any business grants available in your field?

There are many alternatives to traditional bank loans. With a little research, you can find a lot of opportunities to finance your startup and achieve your business goals.

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* This blog provides general information and discussion about global business payments and related subjects. The content provided in this blog ("Content”), should not be construed as and is not intended to constitute financial, legal or tax advice. You should seek the advice of professionals prior to acting upon any information contained in the Content. All Content is provided strictly “as is” and we make no warranty or representation of any kind regarding the Content.