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5 Reasons Why Your Small Business May Not Be Approved for an SBA Loan
We wanted to get some perspective from commercial loan officers on the most common mistakes they see business owners making when applying for a loan, so we put this question to several different lenders — and the responses were surprising.
- Mistake #1: Forgetting (or deliberately withholding) an itemized list of collateral.
- Mistake #2: Not knowing how much you want to borrow.
- Mistake #3: Not having adequate cash flow to pay the loan back (or not being able to prove it).
- Mistake #4: Not having a down payment of 10% prepared.
- Mistake #5: Not cleaning up your credit first.
- Case Study: Ticking All the Boxes
- Find the Right Loan to Supercharge Your Business
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As a business owner, you already know that your financial standing can make or break your business. You don't need to be told that a loan is an investment in the future of your business, or that failing to make loan payments comes with serious consequences.
Still, even the most seasoned of small business owners can face certain stumbling blocks when applying for an SBA loan, such as the increasingly popular SBA 7(a) loan. This is especially the case when business owners are new to the commercial lending process. If you've been bootstrapping it, you may be especially wary of (but excited about) the prospect of borrowing to grow your business.
We wanted to get some perspective from commercial loan officers on the most common mistakes they see business owners making when applying for a loan, so we posited this question to several different lenders — and the responses were surprising.
Here are the top mistakes most small businesses make when applying for an SBA business loan.
Mistake #1: Forgetting (or deliberately withholding) an itemized list of collateral.
"Bankers are not venture capitalists or angel investors. We are lenders," says commercial loan officer David Vernich. 'We need to take safe, prudent risks with the depositors money to make sure we get it all back plus interest."
One way to get on your future lender's good side? Provide an itemized list of all collateral you're willing to put up to back your loan. Although the SBA does provide a guarantee, it's not for the full loan amount -- meaning the bank is still taking on some risk when loaning you money. The easiest way to quell this concern is to show that you have assets you're willing and able to offer up as collateral, and being completely clear and upfront about their valuation.
And although some borrowers may be able to get away with not including this list, SBA lending expert Sameer Shah warns against this. “I have seen situations in which the business or the guarantors hid or didn’t report certain assets. While it’s often something they can often get away with, it’s unethical and can be a serious issue in the case of default.”
Mistake #2: Not knowing how much you want to borrow.
It may be tempting to ask for the maximum amount possible. After all, with more money, you can do more for your business…right?
Maybe, but a much better plan is to define your growth goals first, and then determine exactly how much money you need to get there. Not only will this ensure you don't go too deeply into debt, but it'll also reflect really well on you when you sit down with a loan officer.
If you've planned down to the dollar how you intend to use your loan funds, the lender can trust that you're organized and responsible -- meaning you're a much safer risk than Joe Schmo who just wants to see how much he can get.
Mistake #3: Not having adequate cash flow to pay the loan back (or not being able to prove it).
Your books are your greatest weapon when applying for an SBA loan. Vernich says, "for every dollar of debt, we need to see $1.25 of cash flow from the business to pay it back."
Have all of the following, if possible:
The last three years' worth of tax returns (business and personal)
Detailed current personal financial statement
Proof of cash flow or realistic projections
What are the most common reasons why small businesses are denied SBA loans?
The most common reasons why small businesses are denied SBA loans are:
- Not having a good credit score
- Not having adequate collateral
- Not having adequate cash flow to pay the loan back (or not being able to prove it)
- Not having a down payment of 10% prepared
- Not having a well-written business plan
For more information, please refer to the following sources:
What are the eligibility requirements for an SBA loan?
The Small Business Administration (SBA) has a few eligibility requirements for an SBA loan. These include:
- You must be officially registered as a for-profit business, and you must be operating legally.
- As the business owner, you can’t be on parole.
- Your business must have fewer than 500 employees, and less than $7.5 million revenue on average each year for the past three years.
- Your net income must be under $5 million (after taxes and not counting carry-over losses), and your tangible net worth must be less than $15 million.
- You must show you’re investing your own time and money into the business, having “invested equity.”
- Your business must be physically based in the United States, and you must be doing business with the U.S. and its territories.
- Your small business must be in an SBA-eligible industry (speculative, illegal and non-profit businesses don’t get to play). Learn more about Eligible and Ineligible Industries for SBA 7(a) Loans.
- You’ll need to show that you’ve already tried and failed get funds from other financial lenders, fully exhausting non-SBA loan options.
- You’ll need to prove you’ve got a sound business purpose for the loan you’re requesting, and that your intended funds usage is approved by the SBA.
- You’ll need to prove you’re not delinquent on any existing debts to the U.S. government (taxes, student loans).
In addition to the eligibility requirements, there are a few additional qualities which can increase your likelihood of SBA 7(a) loan approval:
- A good credit score - preferably above 680.
- A history free from recent bankruptcies, foreclosures, or tax liens.
- Having been in business for at least two years.
- The ability to provide collateral for loan requests over $25,000.
- The ability to make a down payment of 10% if your intended use of funds is to purchase a business, commercial real estate, or business-related equipment.
- Sufficient cash flow to meet your debt obligations.
- Sufficient working capital (once you subtract liabilities from assets).
- “Good character” according to the SBA (partially decided based on your track record of managing your resources and day-to-day business affairs).
What are the advantages of an SBA loan for small businesses?
The Small Business Administration (SBA) offers a variety of loan products that can be beneficial to small businesses. These loans typically range from $500 to $5.5 million and can be used for most business purposes, including operating capital and long-term fixed assets. Additionally, the SBA guarantees the loan, which makes banks more willing to offer these loan products to high-risk borrowers. This can be especially helpful for small businesses that may not qualify for more traditional business loans.
The SBA also offers a few easy to remember requirements for businesses seeking SBA financing. These include being a for-profit company, being located in and conducting business in the United States, having owner-invested equity, and not receiving funding from any other financial lender. Business size, ability to repay, and the purpose of the business are also taken into consideration.
Overall, the advantages of an SBA loan for small businesses include access to larger loan amounts, lower interest rates, longer repayment terms, and the ability to use the loan for a variety of business purposes. Additionally, the SBA guarantees the loan, which makes banks more willing to offer these loan products to high-risk borrowers.
What are the disadvantages of an SBA loan for small businesses?
SBA 7(a) loan disadvantages include:
- Lengthy approval times (for standard SBA 7(a) loans)
- Lots of documentation
- Collateral is often required
- Certain businesses, including real estate investing, lending, gambling, and speculation are prohibited
- High credit scores are typically required (typically 680+)
- May be restrictions on supplemental/additional financing
SBA 7(a) Loan Terms and Eligibility: Cons:
- Requires a borrower to put down all business assets as collateral for the loan
- If a borrower doesn't have enough collateral, they may need to put down personal assets, such as home or cars
- Requires borrowers to have significant equity in the business: Startups must typically have $1 invested for every $3 in SBA 7(a) loans, while established businesses usually must have $1 invested for every $4 in SBA financing
- Cannot be used for businesses trying to pay off unsecured debt
- Requires borrowers to disclose personal and business credit histories
- Prepayment penalties are assessed on loans with a 15+ year term
- Guarantee fees are assessed by the SBA on loans above $150,000
What are the best alternatives to an SBA loan for small businesses?
The best alternatives to an SBA loan for small businesses are term loans and small business partnerships. Term loans offer longer repayment terms with minimal restrictions on fund use, and higher loan amounts and lower interest rates and fees. Small business partnerships offer the experience and wisdom of additional experienced professionals, and make your business much more appealing as a loan candidate to banks or other lenders.
For more information on term loans, please see Non-SBA Financing Options for Small Businesses, Alternative #6.
For more information on small business partnerships, please see Non-SBA Financing Options for Small Businesses, Alternative #16.
If you have all of these things, says Vernich, "the probability of success jumps ten-fold."
Mistake #4: Not having a down payment of 10% prepared.
Though you may not always need a down payment, it's a good practice to have 10% of the loan amount on reserve to offer up in the event that it's required, says Kensley Lewis, secretary and loan officer at Commercial Loan Solutions.
Mistake #5: Not cleaning up your credit first.
Unfortunately, “a successful business doesn’t negate a poor personal or business credit score,” says Nicholas Straut of Fundera, a large SBA lender based in New York. And if your credit is in good shape, now’s not the time to be taking on additional debts. If you have other debt or credit payments but your revenue isn’t enough to offset it, you’ll have a really hard time getting a loan. “Be honest, prepare thoroughly, and be realistic!” Straut says.
Anything you can do to show your future lender that you're serious about paying back your SBA loan will work in your favor. “Small businesses should understand that the first thing they should provide is numbers -- numbers that can represent that they can pay back the business loan,” says Paul Jennifer, a Merchant Cash Advance expert.
The bottom line? It doesn’t matter if you have a million-dollar idea: What matters to lenders is the actual dollars.
Case Study: Ticking All the Boxes
Natasha, a passionate educator and entrepreneur, decided to open a school supply store in Spokane, Washington. She envisioned Spokane Scholars as a one-stop-shop for parents, teachers, and students to find high-quality educational supplies and materials.
As she prepared to apply for an SBA loan to finance her business, Natasha faced several challenges that could have prevented her from getting approved. However, she took the necessary steps to overcome these obstacles and secure the financing she needed.
For example, Natasha initially forgot to include an itemized list of collateral in her loan application. She quickly realized her mistake and worked with her accountant to provide a comprehensive list of her assets, including personal property and equipment she intended to purchase for the store.
Natasha was unsure of the exact amount she needed to borrow. She consulted with a financial advisor and developed a detailed budget and financial projections for her business. This allowed her to determine the exact loan amount needed to cover startup costs, inventory, and working capital. She ultimately applied for an SBA loan of $200,000.
To prove that she would have adequate cash flow to repay the loan, Natasha provided detailed sales projections and a comprehensive business plan outlining her marketing strategies and target customer base. She also showcased her experience in the education industry, demonstrating her ability to manage the business effectively.
Although Natasha initially struggled to come up with the required 10% down payment, she managed to secure the funds by tapping into her savings, seeking financial support from family members, and selling some personal assets. She contributed $10,000 from her savings, received $8,000 from her parents, and sold three pieces of jewelry for another $2,000 to cover the $20,000 down payment.
Before applying for the SBA loan, Natasha took the time to review her credit report and address any issues. She paid off outstanding debts, resolved discrepancies, and worked diligently to improve her credit score.
By addressing these potential hurdles, Natasha was able to successfully secure an SBA loan for her school supply store, Spokane Scholars. With the loan funds, she transformed an empty retail space into a vibrant, well-stocked store that catered to the educational needs of the Spokane community. Spokane Scholars quickly became a popular destination for teachers, students, and parents alike, thanks to Natasha's perseverance and determination in overcoming the challenges associated with securing an SBA loan.
This is a fictional case study provided for illustrative purposes.
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