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Why Do Banks Say No to Business Startup Loans?

Why Do Banks Say No to Business Startup Loans?

Why Do Banks Say No to Startup Loans?

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It is very difficult for a new business to get a loan from a commercial bank or lender for business startup. New businesses are in fact the riskiest loans of any that a bank or lender might encounter. So understandably they are nervous about startup loans.

Why Business Startups are Risky

To understand why new business startups are risky for business lenders, take a look at the four C’s of Credit (collateral, capital, capacity, character).

  • Capital- Business assets that can be used to create products or services and which can be turned into cash to make payments on business loans. A new business, especially a service business, has few business assets.
  • Collateral – Cash to contribute to the business. A new business owner has little collateral unless he or she can use personal assets or has a co-signer with assets to pledge.
  • Capacity – A track record to show that the business has the capacity to generate enough money to pay back the loan.
  • Character. This is primarily a good credit rating. if you have a good credit rating (business credit or personal credit), though, it doesn’t mean you can get a business loan, but a poor rating will probably get you turned away quickly.

Other Reasons Banks Deny Startup Loans

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Lack of experience. In professional businesses, it’s common for banks to deny a startup loan to someone who doesn’t have at least a year of experience working in the profession.

Lack of management. In a similar way to the owner having no experience, lenders may online payday AL not be comfortable with a brand new business that doesn’t have a strong, experienced management team to add their help to make the business go.

Lack of customer base. Yes, it’s one of those “Catch-22” situations; you can’t get a loan unless you have customers, but you can’t start your business and get customers without the loan. If you can show that you have some strong customers lined up, that might make a good impression on the lender.

Banks are pretty creative when it comes to reasons for saying no to a startup loan. These are typical responses by banks to a young couple who were seeking a loan to start a professional practice.

Typical Bank Responses to Startup Loan Requests – And Your Response

100% Collateral.One bank said it would give an $80,000 loan at 8% interest if the borrowers would have their co-signer put $80,000 in the bank (at 5% interest). When the borrower asked them why he shouldn’t just take the $80,000 to start his business, they responded, “This way you get business credit.”

Limiting Loan Amounts. Another bank would only give them $50,000, saying that was the limit for “SBA express loans for startups.”

Your response: Before you talk to banks, talk to the SBA. Find out their criteria. Some banks are more willing to deal with the extra paperwork and hassle of SBA loans. You can go to the SBA and get tentative approval, to cut off the bank objections.

Equity from Owner. A bank I heard of said it wanted a “required equity injection” (that is, cash from the owner. If the bank loans $80,000 and requires $30,000 from the owner, the bank is really loaning only $50,000.

Business Loans and Your Business Plan

One of the best ways to get a startup business loan is to craft your business plan carefully to answer all the questions a lender might ask and the objections that might be raised.

  • Show how you plan to contribute capital to the business. What are you contributing to the business yourself? What do you already have (that’s paid for)?
  • Show where your collateral will come from, and the credit records of you and any co-signer.
  • Show the management expertise you, your advisors, and executives have to guide the business quickly to profitability.
  • Include spreadsheets to show when your business will have a positive cash flow (not just profit) and that you are spending less than you bring in.
  • Show your experience with similar businesses, or show you have an experienced management team behind you.

Personal Credit and Startup Loans

Because new businesses don’t have business credit of their own, the bank has to look at the credit of the people who own the business. Banks often deny startup loan requests because the personal credit of the borrower has problems. For example:

Other Ways to Get Money for Business Startup

The best thing you can do if you are denied bank funding is to go to other sources of funding or alternative lenders. Here are some places to start:

SBA loan guarantees. The Small Business Administration (SBA) doesn’t directly loan money, but it gives guarantees to lenders, acting like a co-signer. Yes, there is more paperwork and time involved, but it may be worth it to get your startup loan. The SBA’s 7(a) loan program is a good place to start.

Friends and family. People you know are a possible source of some startup funds. A direct loan or an equity interest in the business (stock ownership) might be possible. If collateral is your problem, find someone who has some personal assets and who is willing to pledge them to help get the business started. You may also be able to find someone who will give the lender a personal guarantee.

Trade credit/Vendor financing. Getting financing from vendors is a way to reduce your need for a traditional loan. If you buy products, materials, inventory, or equipment from a vendor, ask them to give you longer terms or setting up credit accounts. It’s also a good way to build up your business credit rating.

Seller financing. If you are buying a business, you may be able to get the seller to guarantee part of the loan or give you an earn-out provision for all or part, in which you pay the seller back from your profits.

Credit card financing. As a last resort, you might consider credit card financing for your startup. This option is last resort because the interest rates are high and if your sales don’t take off quickly you could be in a deep financial hole.

If all else fails, start very small, cut out what you don’t need, and keep working on it. Being creative and persistent can get you closer to your business startup. Good luck!