When approaching a lender for a business loan, SMEs naturally want to be sure their request will be accepted. The secret? It’s all in the planning.
Courtesy of some helpful insider knowledge from Rob Warlow – Founder of Business Loan Services (UK) Ltd. – this article looks at five common reasons why loans are typically declined.
It’s never welcome news to hear that your business loan application has been rejected. Yet hindsight is, as they say, 20/20, in which case it’s best to be aware of the possible reasons why your SME business loan was turned down, in order to plan for the future.
Rob Warlow, Founder of SME loan broker Business Loan Services, shares his thoughts:
“2021 has seen a lack of lending appetite among the main high-street lenders due to the ongoing uncertainty caused by the pandemic. 2020 saw businesses gorging on debt provided by lenders under the Bounce Bank Loan and CBILS. It is this debt hangover that is now concerning both businesses and lenders alike.”
The economy is now opening up again, and many SMEs will find themselves up against the problem of securing access to working capital so as to fund their daily cashflow requirements. For some, this will prove to be a struggle – potentially causing an increase in the number of firms entering into some form of insolvency arrangement during the rest of 2021 and into 2022.
According to Warlow, SMEs looking to borrow would be advised to begin the process well in advance – ideally six to 12 months ahead of submitting an application. This then gives some leeway to be able to scope out all the options, target the most appropriate lenders and then customise the business and loan application to boost the chances of success.
Below, Warlow discusses the routine reasons why loans are rejected, and how SMEs can avoid this fate:
1. Targeting the wrong lender
Two very distinct groups of lenders have materialised in recent years, namely banks and ‘fintechs’. Traditional banks usually avoid small loans now (as a ballpark figure, below £25,000), whereas fintechs, such as peer-to-peer lenders, lead this end of the market.
While banks have more manual loan-application processes (in a low-interest-rate environment, small loans are just not economical), fintechs usually have highly automated online processes that are very much ‘rules-based’.
SMEs need to therefore earmark lenders that are happy with the size of loan they require.
Another point of note is the importance of finding out which lenders are active in your sector. In the current climate, banks and other lenders are steering clear of or being ultra-cautious regarding some areas – for instance, as is to be expected, obtaining finance can be somewhat problematic now for high-street retailers, restaurants and the leisure sector, as these have all experienced higher levels of stress as a result of the pandemic.
It’s a good idea to have a conversation sooner rather than later with target lenders to ensure they’re active in your sector.
2. Weak credit history (of the business or its directors)
Credit scores are particularly important to fintech lenders because of their automated processes. Banks will sometimes delve into the reasons behind a low credit score, while an automated process simply looks at the score itself and a decision is made.
It’s therefore crucial for businesses to make sure they retain a healthy credit history. Some of the common reasons behind a lower credit scores include:
- Late or last-minute filing of accounts (there can be a few days’ delay from filing accounts to when they’re available for credit-scoring algorithms to read, therefore the algorithm may assume accounts are late if they were only filed at the last minute)
- Late payment of invoices (reporting late payments to credit-scoring agencies is becoming more commonplace – this essentially puts a black mark against the name of the late payer)
- Judgements or payment defaults against the company (a CCJ has a notable negative impact on a credit score).
The personal credit history of directors and large shareholders is likewise critical. Lenders are often reliant on the personal guarantees of directors and will want to ensure they’re in a robust financial position.
The financial repercussions of COVID-19 will now be reflected in businesses’ 2020/21 annual accounts, in which case a further downgrading of credit scores is to be expected – this will negatively affect the ability to raise finance and/or the cost of funds.
3. Financial deficiencies
Lenders will be scrutinising certain financial metrics, and no more so than in the case of larger loans. They will want to see how profitable the business is – with the higher level of debt taken on by firms over the last 18 months, the ability to generate enough cash to comfortably cover Bounce Back Loans, CBILS and the proposed loan repayments will be essential. The lender’s main concern will be the overall burden of debt on a balance sheet.
At present, lenders will expect to be able to access the most up-to-date annual accounts – waiting right up until the filing deadline will be deemed unacceptable. Not only that, but the expectation will also be that the latest management accounts are presented with an application. Annual accounts are seen as historic, and subsequently there’s a need for current-year trading information.
A further point that businesses need to be mindful of is that, sometimes, accountants will (quite legitimately) structure the financials in such a way so as to minimise profit (and therefore, tax). However, this can actually hinder a favourable lending decision. Instead, forward-planning and structuring the financials to suit a loan application will be necessary – and well in advance.
4. Problems with bank statements
Especially in the case of loans above the ‘automated’ assessment threshold, lenders will be looking at bank statements – choosing to reject applications in the instance where repeated patterns of bounced cheques or unplanned overdrafts are apparent.
5. Mistiming the application
Start-ups come with increased risk and a lack of trading record, and are therefore a no-go for debt finance. As a general rule, debt finance can be considered following 12 months of trading history having been established.
The final point from Warlow regarding SMEs is that although the government has launched the Recovery Loan Scheme – thus providing an 80% guarantee to lenders – this extra support will not change the way lenders review an application. Essentially, when it comes to making a decision about whether to support the request or otherwise, they’ll continue to apply all the usual rules regardless.
In conclusion, the take-away message is to get ahead of the curve and plan your borrowing strategy – well in advance – before approaching a lender for finance. In case of doubt, always consult your financial adviser to be sure you’re fully prepared.