Small businesses play a vital role in driving economic growth and innovation. They are the backbone of local communities, providing employment opportunities and catering to the diverse needs of consumers. However, amidst the challenges and uncertainties of the modern financial world, accessing the necessary capital to start, expand, or sustain a small business has become increasingly difficult.
In addition, traditional lending institutions, such as banks, have tightened their lending criteria, imposing stricter requirements and scrutinizing applications more closely. According to Reuters, as of June 2023, the approval rate of small business loans was only 18.8% from small banks and 13.4% from large banks. But why are banks not willing to lend money to small businesses? This article will shed light on why it is getting harder for small businesses to secure loans from banks and the steps small business owners can take to secure financing.
Why Is It Getting Harder for Small Businesses to Secure Loans?
Securing small business loans has become more challenging due to several reasons:
- Stricter Lending Criteria: Traditional lending institutions like banks have tightened their lending criteria. This is in response to the global financial crisis and subsequent regulatory reforms. They now conduct more thorough assessments of loan applications, focusing on creditworthiness, business stability, and collateral requirements. Also, this increased scrutiny makes it harder for some small businesses to meet the stringent criteria and qualify for loans.
- Economic Uncertainty: Uncertain economic conditions make lenders more cautious about extending loans to small businesses. These include market volatility and changing consumer preferences. Additionally, lenders may perceive higher risks in uncertain times, making them more conservative with their lending practices.
- Limited Financial History: Small businesses, especially startups, often lack a robust financial history or a track record of profitability. This absence of substantial financial data makes it challenging for lenders to assess the business’s creditworthiness and repayment capacity, thereby reducing the likelihood of loan approval.
- Collateral Requirements: Many lenders require collateral to secure small business loans. This can be a significant barrier for businesses without substantial assets. Lack of collateral or insufficient collateral value can also hinder loan approval or result in unfavorable loan terms.
What Can Small Business Owners Do?
It may be increasingly difficult to obtain financing for your small business, but the money is still out there. With the right strategies, small business owners can increase their chances of securing funding.
Strengthen Personal and Business Credit
Maintaining a strong personal and business credit history is crucial. According to a Goldman Sachs Survey, 70% of small business owners confirmed that their personal credit was considered when they applied for a business loan. Moreover, a score above 700 increases one’s chance of securing financing and vice versa. Small business owners should focus on building and maintaining good credit scores. Pay bills on time, reduce outstanding debt, and manage credit responsibly.
Prepare a Solid Business Plan
Creating a comprehensive business plan that outlines the company’s objectives, market analysis, financial projections, and repayment strategies demonstrates professionalism and commitment to lenders. A good business plan typically needs to include a summary of your business, products or services offered, market, and financials.
If you’re unsure of how solid your business plan is, it’s advisable to talk to a business plan expert or a business attorney who will review it and offer feedback on the necessary changes. You also need to be able to explain how you intend to use the money. Demonstrating a grasp of finances and a plan fosters confidence in lenders about our ability to effectively use funds.
Build Relationships With Lenders
Establishing relationships with local lenders or community banks can be beneficial. Engaging in regular communication, attending networking events, and building rapport with lenders can increase the likelihood of loan approval as they gain a better understanding of the business and its potential.
Consider an SBA Loan
An SBA loan is a loan program offered by the US Small Business Administration. The SBA does not directly provide loans to businesses but instead guarantees a portion of the loan amount (usually 85%) issued by approved lenders, such as banks and credit unions. This guarantee reduces the risk for lenders, encouraging them to provide loans to small businesses that may not meet conventional lending requirements. Section 7(A) and 504 are the most popular loan programs because they allow small businesses to borrow up to $5 million.
Explore Alternative Funding Sources
Traditional bank loans are not the only option for small businesses. Exploring alternative financing avenues such as online lenders, angel investors, community development financial institutions (CDFIs), microloans, or government-backed loan programs can offer additional opportunities to secure funding.
You can also consider bad credit loans or short-term loans. Lenders offering bad credit loans do not always consider bad credit when providing financing options. In such instances, they’ll consider cash flow and bank statements to determine eligibility. Short-term loans are usually offered by online lenders and are generally repaid within a year or less.
Optimize Financial Records
Maintaining accurate and up-to-date financial records is essential. Lenders often require detailed financial documentation, including balance sheets, profit and loss statements, and cash flow statements. Every document helps assess your risk level and determine whether loaning you money is a sound decision. Organized and transparent financial records instill confidence in lenders regarding a business’s financial health.
Seek Expert Guidance
Engaging with small business development centers, financial advisors, or industry-specific mentors can provide valuable insights and guidance throughout the loan application process. These experts can help identify suitable financing options and navigate the complexities of securing loans.
Talk to other people who have been through the loan application process and gotten approved. Also, find out what they did to secure financing. Their insight may be able to help you determine aspects of the application you may have missed.
While the process of obtaining small business loans has become more challenging, entrepreneurs can adapt by understanding the reasons behind the increased difficulty and employing strategic approaches. Adapting to the evolving loan landscape and proactively exploring various options will enable entrepreneurs to overcome obstacles and fuel their business growth and success. If you need help starting your business or are looking for invaluable guidance and legal protection as you start your business, look no further than Brenden Kelley Law. Contact us today to schedule a consultation.