Few things can be more frustrating for a small and midsize business (SMB) than receiving the dreaded “business loan denied” message from a bank.
Yet, that’s exactly the message that the majority of SMBs receive after applying for a loan. As at January 2019, only 29% of SMB loan requests were approved by major banks, with the smaller banks approving just 48.9%, according to the Biz2Credit Small Business Lending Index.
The problem with the high rate of small business loan denials is that SMBs are responsible for 64% of new jobs created in the US economy, making up 90% of all businesses operating in the country, according to the U.S. Small Business Administration.
However, despite their oversized contribution to the economy, SMBs still struggle to access critical funds needed to grow their business and create new jobs. According to the Financial Times, SMBs globally face a massive $2 trillion funding gap.
However, knowing that there is a problem is not enough. As a small business owner, you should clearly understand why this loan funding bottlenecks exists today as a prelude to solving it.
In this article, we’ll consider six common reasons why SMBs receive the “business loan denied” message from banks.
Have you been denied business loans by your bank? At Duckfund, we make sure we learn as much as possible about our clients to increase our loan approval rates. Loan applications take less than one minute to fill out, and funding lands on your account in just 24 hours. Contact us and we’ll help your business understand the best way to move forward.
Before banks can give a loan to a business, irrespective of its size, they need to be sure of its creditworthiness. For SMBs, they do this by evaluating the credit history of the business and, in most cases, the owner.
The credit history of an individual or a business is reflected in the credit score, which is attached to the Social Security Number (SSN) of the individual and the Employer Identification Number (EIN) of the business.
Currently, the most popular credit score system is the one by FICO, which is used by 90% of lenders in the US. The FICO score measures the likelihood that you or your business will repay a credit facility based on your past credit activities (how well you pay back credit as at when due, the volume of outstanding debt, how much of available credit you have used up etc.).
If your credit score is poor (typically between 300 and 570 on a scale of 300-850), banks, and even some alternative lenders, will most likely deny your loan applications since they perceive you as a high-risk customer solely based on your credit history.
Similarly, if you are a small business with little to no credit history, banks will still consider you a high-risk customer. Take the example of a small-scale farm (growing any number of products) that has depended on funds from personal accounts or from friends and family, but now sees an opportunity to expand due to rise in demand from factories higher up in the supply chain.
Irrespective of the valuable relationship the farm has built with these manufacturers, a lack of a credit history will disqualify the farm from a traditional bank loan.
Since the farm has no credit history, they are unsure how the owner will behave and won’t bother taking on the risk needed to issue a small business loan.
Beyond the credit score, many SMBs find it difficult to provide the financial documentation that banks usually request to evaluate to make lending decisions.
In 2015, Forbes mentioned that only 10% of SMBs can produce accurate, organized, and timely financial statements.
“The reality is that for most small businesses, the traditional process of organizing and managing their finances is too complex, too difficult, and too time consuming,” according to the Forbes article. “Even accounting systems like QuickBooks require either a baseline level of accounting knowledge or a dedicated bookkeeper.”
— Forbes
Though SMBs form an important part of most functional supply chains, the inability of lenders to gain clear visibility into their accounting and business information make them less willing to issue them loans.
To continue with the example of the small-scale farm, apart from insufficient credit history, our farmer will most likely lack the financial documentation that big and even smaller banks will require to process a loan request.
This lack of thorough or consistent financial documentation is a common deterrent for traditional lenders.
Insufficient credit history and limited financial documentation (including insufficient collateral and poor cash flow) are often typical features of smaller businesses that supply raw materials to bigger companies.
In many cases, they don’t even have a direct relationship with the supplier.
In our example of a small-scale farm, the owner usually sells to a bigger company that then supplies these products to another bigger factory. This chain will then go up to popular brands (such as Nestle in the case of food producers).
Because these companies at the top of the supply chain are well-established – with detailed financial information, big assets, good credit history, among others – they are the recipients of most financing opportunities.
Trade financing options are typically only available to established tier one suppliers (large companies) able to jump through the hoops necessary to convince a lender that they’re a safe bet,” according to The Global Treasurer, a knowledge resource center for cash management and finance professionals.
The companies that fall out of the tier one bracket don’t have access to the same financial opportunities because lenders are unwilling to enroll these sellers onto financing programs. Why? Because they lack visibility into the companies, which leads to increased financial risk that makes financing just not worth it.
Consequently, though these small-scale suppliers contribute to the supply chain, with good business relationships with the top suppliers, they are left to look out for themselves as most financing opportunities elude them.
There are several options for the small businesses to get funded if they provide collateral and/or personal guarantees.
However, many small business owners are unable to provide the required collateral or are unwilling to guarantee the loans with large personal assets, which can appear incommensurable (e.g. the owner’s home).
In our example, small-scale farmers may not have expensive equipment that can be used as collateral for the capital needed. Even if the owner has a home to put up to the bank, they are probably reluctant to guarantee a business loan with it.
Though there are unsecured business loans that don’t require collateral, they are often smaller amounts at higher interest rates (which is why they are not ideal for SMBs).
Moreover, the absence of collateral is usually compensated for with a more stringent evaluation of credit history and financial information (which SMBs typically fall short of).
If you are one of the SMBs that have accurate and organized financial statements, you might still be doomed to receive a “business loan denied” message if your current cash flows are considered insufficient to service your loan obligations.
In fact, providing sufficient cash flow remains the primary challenge for SMBs, which explains why many are denied for small business loans. A 2019 study by Intuit, the provider of QuickBooks (accounting software for SMBs), shows that 61% of SMBs suffer cash flow problems.
Ironically, the latter study shows that lack of financial support is part of the reasons why SMBs suffer cash flow problems. So, while poor cash flow hinders access to funds, the latter also perpetuates the former in an unfortunate chain of cause and effect.
So, suppliers down the supply chain like the local food producers can’t provide enough cash flow to be considered for loans, the same loans they need to improve their businesses and improve their cash flow.
No wonder small business owners are left stuck in this vicious cycle.
In addition to the risk perception of an individual SMB, banks must also evaluate the inherent risk of the industry in which the company operates.
Industries such as gambling and house flipping are often blacklisted, while restaurants and construction businesses are often underserved due to concerns about the profitability of the former and the seasonality of the latter.
The 2020 State of Small Business Lending Report by Fundera shows that there is a list of favorites for the SMB lending industry, which include:
Businesses outside of these industries might struggle more to gain access to the finance which they need as much as the others. This includes small companies that work deep down in the supply chain, often supplying many of the important components that help the above industries succeed.
What can you do if you have been denied small business loans due one to these reasons?
Well, first of all, your need for a small business loan has probably not changed. Your company still needs access to financing to meet operating expenses and to fund growth, and you have probably considered even asking friends, family or taking out personal business cards.
But what if you could look beyond banks and other lenders to a solution where you could access the loans you need without jumping through all of these hoops?
Acquiring a business loan shouldn’t be a hassle, especially for small businesses that sit deep down the supply chain and represent the core job growth engine of our economy.
Duckfund was created to give fair funding access to small businesses, better facilitate loan application procedures, increase approval rates and make borrower's life easier.
Instead of relying on credit history and limited financial statements, Duckfund uses AI-based business analytics tools to collect business and financial information about your business.
By working with the software companies you use (including popular marketing, sales, accounting, invoicing, CRM software), Duckfund can go beyond traditional credit score information demanded by banks and other alternative lenders by analyzing anonymous data that helps us understand what your business is really about and its true potential.
Rather than cater only to big companies, we use our business analytics tools to gain more visibility into the flow of capital of small businesses and learn just how they are connected with larger companies up in the supply chain.
This information is then used to create a unique credit scoring model, which is meant to better reflect an understanding of your business.
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Based on the information above, we’ll offer you the funding option that will best suit your business. Currently available financing options include term loans and trade finance.
Whatever the financing option, we offer affordable interest rates and suitable terms.
What's more, Duckfund is able to make funds available within 24 hours.
This is because we are a nimble fintech that is able to handle background checks (with your approval) and release the loan quickly.
Once financing is made available, you can use our online platform to access the money, manage your business finance, accounts, and repayment installments.
Do you want a personalized lending solution that does not require overcoming the massive hurdles set up by modern bank loan programs?
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