Getting a loan is an almost inevitable part of running a business but running the gauntlet of lender approvals can be a daunting task.
There is almost nothing worse for a SME than when the bank denies you a loan, and the past few years including the Royal Commission and the recent pandemic means, there has been a general tightening of credit.
Banks, or other lenders, often provide unfortunately opaque reasons for denying a loan, that are often misunderstood by business owners.
We unfortunately know all about it; in a former life, we were the ones accepting and denying SMEs for loans (and being equally vague about why).
We wanted to share our insights into how banks make these decisions and what business owners can do to maximise their chances of getting a loan.
The first step you should always take if rejected for a loan is to revisit your business fundamentals, understand and fix them. Fix your business fundamentals and then, come back to the bank, or as a second step understand your options outside of it.
In the most (over) simplified way possible, bankers assess:
- Character of borrower
- Capacity to repay
- Collateral to support the loan
So, here’s what you need to know about these three categories.
- Character of the borrower
This is about you and your business alike.
What kind of business do you run: First of all is how you present your business. While being a “startup” is appealing to investors and lends towards a certain buzz, if you want a loan you’re better off framing your business as a SME.
Banks generally tend to lend to established businesses which have a clear purpose, are generating profit (particularly cashflow), ie, not higher risk companies.
Experience: The bank will also see it as a positive if you’ve got relevant experience. If you’ve been through multiple business cycles, seen highs and lows they will assess you positively in this respect.
Personal character: No banker will be able to refuse a loan without a good reason, but gut feel tends to lead towards a yes or a no. That means if you’re honest, transparent and respectful, it may actually help!
- Capacity to repay
Think about a concept of the “jaws”. If your income is going up, and expenses are going down, they are open. If it’s the opposite, they are closed, like the bank will be.
Can you repay the loan: this is pretty straight forward, but you need to be able to able to show you can repay the loan on a conservative basis. The current low interest rate environment should improve everyone’s capacity to pay; however banks are generally assessing you on a relatively higher rate (affordability), which can at times be 2 to 3 percentage points higher than the quoted rate. Banks will also consider repayment of the loan over a reasonable timeframe (3 to 5 years for a business loan) depending on the request.
Does your business operationally make money: Banks will consider things like investment for growth, but they want to know that for every product or service you sell, you are covering the cost of doing that directly. At minimum do you make a good gross margin?
Right now: Banks are more conservative, they’ll look at what you did last year and over the last few years. They are putting a lot less weight on future outlook, and they will most likely, heavily sensitise your assumptions.
Tax focus: Many businesses also structure their books to be most beneficial at tax time.
However, a tax-focussed accounting strategy does you a disservice to what you need to get a loan from the bank. You want to take advantage of tax but understand the economic reality of doing this. You may benefit in the short term from the tax deduction, but lower profits to reduce your tax bill will reduce your borrowing power, and your ability to capitalise (pun intended) on growth opportunities.
- Collateral to protect the loan
Assets: what collateral do you have to support the loan and how will external factors affect these? For example, the family home is a common asset, but fluctuations in property prices can have an impact. Or take a look at what you’re buying, the bank is likely to have said no for a reason – they may not have appetite for the asset you’re trying to buy.
So they said no...
If you can’t get a loan, we’d encourage you to look at the above and think about why.
Depending on the reasons, getting a loan on a business which isn’t working will end up hurting you more and you may end up losing more than you already have.
Use the rejection as a moment to step back, fix what’s wrong, or find another path.
Jun Yan is the co-founder and director at Ravit Insights. Prior to this, he was a commercial banker at NAB.