Researchers at Pepperdine University have completed a series of surveys trying to better understand why many small businesses get rejected by banks when applying for a loan. Their analysis has lead some business owners to completely rethink they way they manage their finances.
The university found quality of company earnings and cash flow to be the main reasons banks rejected loan applications. The quality of company earnings refers to the stability, strength, and consistency of a business’ revenue over a set time period (usually six months to a year) and whether this profit is is relevant to to it’s core business. Craig Everett, director of the Private Capital Markets Project at Pepperdine University, explains. “If earnings were higher this year but it’s because you had a big profit from a real estate deal and you’re a dry cleaner, that doesn’t count.” Everett said.
Not having enough collateral and debt liability were the next most common reasons, according to the banks surveyed. Although collateral is not required by banks all the time for medium to larger sized businesses, collateral is almost always required for smaller businesses. The Pepperdine 2014 survey found that banks required collateral 100% of the time for loans of $1 million, but that percentage dropped to 63% for loans of $100 million. Similarly, personal guarantees are typically required for loans below $5 million, according to the survey.
Some small businesses experience major hurdles when they deliberately drive up expenses in an attempt to minimize taxes. This ends up hurting them in the long run when they go and apply for a loan or try to sell their business. “A lot of small businesses, to be frank, really don’t manage their businesses in order to maximize earnings because they’re trying to minimize taxes, so they’ll have a lot of expenses,” Everett said. “But of course, that hurts them when they go to sell the business or get a loan.”
Although bank’s requirements make it tough for small businesses applying for financing, private lending companies still continue to fund more small businesses with their more flexible lending criteria. However, they often look at certain aspects of a business many people find a little surprising . Find out the top reasons private lenders say no, and what qualities of a business they look for on this page: