At a glance
- A business loan could help you secure much-needed funds without diluting your equity. It’s important to know the reasons why a loan application may be turned down.
- The credit score of your business and its directors can affect your chances of acceptance. Avoiding things that may reduce credit scores, such as late filing of accounts, late payments or defaulting on payments, can help.
- Planning well in advance is also important, for example by ensuring your business’s finances are structured appropriately.
During the economic downturn, you may find it challenging to secure a loan to fund your company’s cash-flow needs. But there is much you can do to ensure the best chance of being accepted.
SME lending figures were lower throughout 2022 compared to pre-COVID-19 times.1 This suggests ongoing uncertainty caused by the pandemic, war in Ukraine, high inflation and rising interest rates has taken its toll.
But if firms cannot get the working capital they need, they could face greater financial stress.
Why apply for a business loan?
Though applying for a loan may be hard work, it can still be worth the effort. Edward Blackmore, Business Development Director at luxury asset-backed lender Suros Capital, says that taking out a loan, rather than raising capital from investors, enables SME owners to retain their business share rather than sell equity.
“An investor may insist on controls that limit the entrepreneur’s freedom to run the business as they see fit,” he says. “A loan enables the owner to continue operating with autonomy.”
Another benefit is that loans can often be secured quickly and confidentially, provided your credit check supports the loan, or you have sufficient assets to back it for secured lending.
However, lenders may decline a loan for many reasons, especially in tough economic times. So SME owners looking to borrow should prepare early, ideally six to 12 months before applying. This will allow you time to research all options, tailor your business and loan application, and target the most suitable lenders.
5 common reasons loans are turned down
One of the best ways to increase your prospects of getting a loan is to look at the main reasons loans are declined and make sure they don’t apply to you or your company, where possible.
1. Poor credit history for your business or its directors
Credit scores are important to most lenders of non-secured loans. This is especially the case with financial technology (fintech) lenders because they rely on automated processes. Banks may delve deeper into the reasons for a poor credit score, but a computerised process just looks at the score and makes a decision.
Avoid common reasons for lower credit scores, such as:
•Last-minute or late filing of accounts. There can be a few days’ delay between when you file accounts and when they are available to credit-scoring algorithms, so the algorithm may conclude you are late, even though you filed them just before the deadline.
•Late payment of invoices. If a late payment is reported to credit-scoring agencies, which is becoming more common, this puts a black mark against your name.
•A payment default or judgment against your company, such as a County Court Judgment, can significantly damage your credit score.
The personal credit history of large shareholders and directors is also significant. Lenders often rely on directors’ personal guarantees.
The financial impact of COVID-19 will now be reflected in many firms’ 2021 and 2022 annual accounts, which may mean a further downgrading of credit scores, impacting ability to raise finance.
2. Financial weakness
Especially for larger loans, lenders will study your financial metrics, such as profits and the overall debt on your balance sheet. Your ability to generate enough cash to cover loan repayments will be critical.
Lenders will look at your latest annual accounts and up-to-date management accounts for the current year.
Sometimes accountants will, legitimately, structure your finances to minimise profit and tax. But this can work against a lending decision. This is a key reason for planning your finances to suit a loan application well in advance.
3. Applying to the wrong lender
There are two distinct types of lender: traditional banks and fintechs. As many traditional banks have tended to avoid small loans – roughly below £25,000 – fintechs, such as peer-to-peer lenders, have moved into this sector of the market. Be sure to target lenders comfortable with the loan size you need.
Identify lenders active in your sector. In tough economic times, banks and other lenders avoid or are ultra-cautious in some areas. For example, obtaining finance can be difficult for high-street retailers, restaurants and other resource-heavy businesses as they continue to battle the effects of the pandemic and inflation.
4. Your business is too young
Start-ups are generally unable to access debt finance because they lack a trading record and lenders see them as higher risk. Debt finance can become an option after 12 months of established trading history.
5. Bank statement issues
For loans above an automated assessment threshold, lenders will look at your bank statements and reject your application if you have repeatedly bounced cheques or had unplanned overdrafts.
How we can help
When considering taking on a loan, it’s important to have a good overview of all your finances – business and personal.
For example, is there a way you could use personal money to fund your business rather than going to the bank? Are there tax-efficient measures that could take the financial pressure off your business?
Ensuring your business is well protected, for example with key person insurance, may also curry favour with lenders, as it demonstrates prudence and reliability.
Speaking to us can help you assess all the options* and model your cash flow to understand how various scenarios will affect your funding and cash positions. Plus, we can help you with business protection, which can give prospective lenders some additional assurance that you will meet loan repayments even if the worst should happen.
*Some options may involve the referral to a service that is separate and distinct from those offered by St. James’s Place.
Commercial loans are not regulated by the Financial Conduct Authority
1Money and Credit – December 2022, Bank of England, January 2023
SJP Approved 28/02/2023