Why the banks will decline your business loan application (and how you can best prepare yours)
Need to stabilise your cash flow? Keen to expand your capabilities? If the time has come for your business to engage in strategic borrowing there are some important steps you’ll need to take, to boost your chances of getting the business loan you need.
The challenge of bank finance
You’re probably aware that since the 2008 GFC, Australian banks are very risk-averse. Only a small percentage of loan applications from small businesses get approved – and the majority of those that do are for well-established SME’s with several years’ trading history, consistently high turnover and plenty of juicy assets to offer as collateral.
Unfortunately, banks tend to have numerous criteria that you’ll need to satisfy before qualifying for a business loan – fail to cross the line on any one, and the chances are your application will be rejected without a second glance.
Here are the top 3 reasons banks turn down business loan applications from SMEs:
- No collateral
Above all else, banks want to know that if they lend you money, they’ll get it back – one way or another. Securing a loan against an asset, whether it be property, a vehicle or a marketable piece of equipment, gives them solid reassurance that if you fail to meet your obligations for any reason, they have nothing to lose.
Bear in mind that 60% of small business loans are for less than $100,000. For a major bank the amount they’ll make in fees and interest on a loan that size is barely significant – which means it simply isn’t worth the risk for them unless the loan is fully secured.
- No track record
The last thing the bank wants is for you to default on your loan. Yes, their interests may be protected by the collateral, but they’d still have to go through a potentially lengthy and expensive process to recover their money – as well as missing out on all the interest.
Banks go to considerable lengths to check that the businesses they lend to are likely to survive, and to generate enough profit during the period of the loan to cover repayments, fees and interest. Unless you can show that your market is stable, your business is thriving, your management knows what it’s up to and your cash flow is steady, you may just look too risky.
Any of these scenarios are likely to raise red flags to a bank:
- You haven’t been around long enough to prove your business model is viable
- Your industry is weakening, or you occupy a weak position within your sector
- The majority of your revenue comes from just a few suppliers
- Your income is seasonal or inconsistent
- Your clients are slow at paying, leaving gaps in your cash flow
- Weak credit rating
While it’s obvious that any black mark on your credit record can get your application rejected, you may be surprised to learn that other factors can have a serious negative impact. Believe it or not, having no credit history at all can count just as heavily against you, because to a bank it means you’re a big unknown. It’s far better to build a history of borrowing and repaying smaller amounts (e.g. by using a business credit card) to show you know how to handle debt, than to remain debt free.
Too much activity on your credit record can also raise flags, so beware of contacting multiple institutions about potential financing – wait until you’ve narrowed down your options and identified the lender that’s the best match for your needs.
My business meets the criteria – how can I prepare?
None of these issues apply to you? Great! The key to securing bank finance with the minimum hassle is solid preparation – so before you apply, take these 5 important steps:
- Prepare a thorough business case for the loan. This is for your own benefit as much as the bank’s – identify how much you need to borrow and for what period, how the money will be used to grow or stabilise your business, and how you intend to handle repayments.
- Update your business plan. Give the bank a clear picture of your business position and capabilities by including SWOT analysis, performance analysis and details of your current business model and strategic plans.
- Compile comprehensive financials. You’ll need 3 years’ P&L statements and balance sheets plus robust cash flow forecasts.
- Take advice. The type of financing you select and way you structure your loan can have a big impact on the overall cost, so it’s wise to seek professional financial advice before you apply.
- Choose your lender. Rates, terms and conditions – as well as appetites for lending to different types of business – vary between banks, so research your options before selecting a product to get the right package to suit your needs.
Not sure I’m right for a bank business loan – what’s the alternative?
If you think your business might not meet the big banks’ criteria, all is not lost. There are an ever-growing number of alternative finance providers in Australia who are willing to offer unsecured loans and other types of business finance to SME’s.