Why It’s Harder Getting Approved for a Business Loan During a Recession
Every day I get calls from business owners looking to get a business loan or a business line of credit. Sometimes they move forward with getting it in place with my company and other times they decide to shop around. In so many of these cases, the business owners haven’t ever applied with a bank before for a business loan and find it surprising to learn how hard approval is especially in a recession (economic downturn caused by
COVID). Applying for a business loan is a lot different than applying for a mortgage. Compound this is the fact that during any recession (slowdown) or time of financial crisis, banks are actually more risk-averse.
I personally have applied for several business loans and business lines of credit over the past 25 years so I know exactly what a national or community bank will look for to approve your business loan application. If you have what a bank wants for approval, then a bank is probably the least expensive option for a business loan.
Economists in the United States have been predicting another recession soon to come. As a business owner your time is super valuable, so let’s cover what a bank is going to look for in approval of a business loan so. I will also cover what other alternatives you have.
What Will a Bank Look For To Approval a Business Loan
Everyone thinks that if you apply for a small business loan with a traditional bank that the bank will approve your business based on a good business plan, good yearly revenue, and a lot of cash flow. The fact of the matter is that banks are the most risk-averse lenders in business financing. Banks have their own set of criteria which even gets tougher when there is an economic downturn. They also have their own language when you apply for a new loan and as a business owner, you have become familiar with their language.
Banks Want Collateral
Banks will not approve your new loan unless you have collateral (also called security) to back up the loan. The collateral could be business or personal collateral in the form of assets such as real estate (home equity), inventory, or any other form of easily sellable assets that could be sold in cases of loan default.
The Federal Reserve audits banks because two main reasons. Banks are loaning funds out to borrowers from both their own bank deposits and get loans from the federal reserve, and bank auditors require businesses to put up collateral.
Banks Will Want Personal Guarantees
Every business owner wants to get their personal guarantees off of business loans, leases, and other business financings. However, until your business is doing $10 million or more in yearly revenue banks will be very reluctant to remove your personal guarantee from any business loans. If you are a new home buyer, watch out because this means your house and other assets will be on the hook if you default. For example, unlike most mortgage payments or student loans that you can refinance, business loans may not be so flexible.
Banks Want a Strong Personal Credit Score for Creditworthiness
National and community banks want at least a 680 or better credit score for approval and if you have a business partner who has a really weak credit score, then you might have some problems being approved. Banks will look at your credit report for creditworthiness so if you walked away from paying a loan or other obligation of significance, this causes them issues.
Banks also don’t really check your business credit score if your yearly revenue is under $10 million because in most cases, your Dun and Bradstreet report isn’t really that accurate yet. Dun and Bradstreet report come from your trade lines from the suppliers you work with. That is why not paying your supplier on time can come back to bite you if you are applying for a business loan.
Banks Want a Strong Balance Sheet
Most small business owners don’t pay close attention to their balance sheet but banks do. In fact, one of the top reasons bank loans can be approved or denied is because of balance sheets. The problem is that often a small business balance sheet isn’t always accurate because of the way that your assets/liabilities can be inputted by your bookkeeper. Make sure that before you apply for any bank loan that you have your CPA revenue both your income statement and balance sheet to ensure that it is properly recorded.
Banks Will Avoid Certain Industries
There are certain industries that banks will just never loan to which might include having potential bad PR or previous experience of the bank. Sometimes it is just a good idea for you to ask your bank loan officer if the bank works in your industry so you don’t waste your time filling out a loan application.
A Bank Loan Application Takes Time
I have a large line of credit myself with a bank and I just finished the renewal application. Every year I have to send in several documents in order to renew my business credit line. Regardless if you are applying for the first time or renewing a business line of credit, be ready for it to take a long time to fill out all the forms and to produce the needed paperwork. Banks are going to want your business and personal tax returns for the past 3 years. They are going to want to see a current income statement, balance sheet, AP, and AR report.
One of the most time-consuming parts of the application will be the personal financial statement. The PFS is a record of all your personal assets and liabilities.
The total time it takes to apply, get successfully approved, and set up a small business loan or a small business credit line will be 3-6 months.
Liens From Other Lenders
Every time you take out a loan, lease, or business financing, the lender will put a lien against your business. The way a lender does this is through a UCC (Uniform Commercial Code form). This legal document tells all other lenders that they have a lien against your assets. Often times a business owner doesn’t even know that a UCC is filed against his company until the bank notifies you.
Banks will always want to be in the first position so you might be required to talk to past or existing lenders to make them aware of the banks’ wishes so they can remove their lien.
Do Banks Offer an Unsecured Business Line of Credit?
An unsecured business line of credit is a credit line that doesn’t require collateral. When the economy is good a financial institution might be willing to offer your business an unsecured business line of credit. The approval may depend on how long you have been doing business with the bank, the type of business you are in, the balances you keep in your bank accounts, the number of transactions you are doing, and your personal credit score. Most unsecured business lines of credit will be well under $100,000 and will be based on your revenue. If you are doing under $1 million per year in revenue you can expect your unsecured credit line to be in the $20,000 or less amount depending on the industry you are in. Overall, getting an unsecured small business line of credit is extremely hard.
What Interest Rates and Fees Do Banks Charge
Just like a home mortgage, banks will always charge upfront points for a business loan and business credit line. A Point is equal to $1,000 and often the bank will charge 3-4 points or $3,000-$4,000 for the initial business loan. In the case of a business line of credit, there is also a yearly maintenance fee of around $500-$1000 and if you have to get something appraised, there may be a charge for that as well. The costs all add up.
The interest rates that a bank will charge will examine the prime during that time. In the cases of a term loan, banks will take the prime rate and add a few points based on what they deem is your risk factor. In the cases of a line of credit, you will pay monthly interest on the amount of money you have outstanding and the bank will use the prime rate at a specified time each month as stated in your contract.
Converting a Business Credit Line to a Term Loan Due to Default
Each year your financial institution will review the performance of your company to determine if their funding is at risk. If the bank becomes concerned and you have a problem with the repayment, the bank can switch your credit line to a term loan which will allow the bank to pay down your line of credit through a monthly payment (refinancing). Although banks want you to use your credit line they also want to ensure that you always have enough liquidity so you can pay the line off. Often times banks will put in your contract a 30 day clean up period where they want your credit line paid down to zero. This then gives the bank the right to cancel your line of credit.
Is an SBA Business Loan a Good Option
The SBA or Small Business Administration’s goal is to help small business owners get the capital they need to build their business. However, what many people don’t know is that the SBA doesn’t actually provide loans. The SBA works with approved and certified banks/lenders that approve loans based on a lower set of criteria.
What the SBA does do is underwrite a part of the loan so that the risk is reduced for the bank allowing you a better chance of being approved. What you should know is that the same approved criteria that banks use if you went directly to the bank are the same criteria an SBA-backed loan would use. However, the standards might be a little lower when it comes to collateral or credit requirements.
What you should know is that it isn’t uncommon for an SBA loan to take more than 6 months to get in place.
The Great Recession and Business Loan Programs
The great recession during 2008 is a case example of what happens to bank lending during a major economic downturn. In 2008 banks just stopped lending to small business owners and it created a whole new alternative banking industry that has now changed the landscape for who small businesses turn to for business loans and business credit lines.
In 2008, private alternative financing companies like mine, Financing Solutions, began giving out small business loans and business lines of credit because the banks where just not lending. There was also a pent up demand of good small businesses that just got sick of dealing with the bank approval processes.
Now 8 out of every 10 small businesses with yearly sales under $5 million who have a business loan use an alternative financing company. The two biggest reasons business owners give for having a hard time with approval include all the requirements and paperwork associated with it.
The COVID/Coronavirus Recession (economic downturn) Affecting Bank Approvals
A Recession (or even a pandemic) can have a major impact in who banks approve for a business line of credit or business loan. There are times during economic uncertainty when a bank will just tell its owner underwriters to not approve any more loans or even to start to be tougher on credit line renewals. Underwriting is a term financial institutions use to identify the bank office which will evaluate your loan application to decide if the bank should approve your request.
The reason large and small banks are so risk-averse is that if a client defaults on a loan then it really affects the profitability of the bank. Defaults have a multiplier effect on a bank because banks borrow money from the Federal Reserve. Also, if there are too many defaults then the bank’s auditors will start to limit the number of funds that banks can borrow and lend out.
The other fact is that banks have a super slim profit margin when it comes to small business lending off only a few points. Once a default happens it takes the bank a few hundred good-paying business clients to make for the loss.
Needless to say, if you haven’t applied for a small business loan before the 2020 pandemic will have a major impact on your ability for approval.
Can A Credit Card Act as a Business Loan or Credit Line?
Yes, A credit card can be a form of a business loan or credit line for your business however, there are a few problems.
One is that often the approval amount on a credit card is small. Approval for a card amount of $10,000 or less is not unusual, unlike years ago.
Second, credit cards are extremely expensive if you do not pay them off monthly. If you are continuing to use your credit cards as a cash advance, it can have a huge impact on the company. National and small banks will take into account credit card debt in their evaluation of your business loan application.
Lastly, all credit cards small business owners require a personal guarantee. The balances you keep on those cards will negatively affect your personal credit score. This will greatly affect eligibility for business financing.
Financing Solutions, an A+ and 5 stars rated BBB company, is a direct lender that provides small businesses and nonprofits with a line of credit.
The FS line of credit costs nothing to set up, nothing until used, and is inexpensive when needed. it is intended to be a great cash backup plan for emergencies and new opportunities.
The credit line requires no collateral and no person guarantees and can be put together. This eliminates the time it takes for the business owner to be involved in filling out paperwork. We will ask for a recent tax return, 4 months of bank statements, a driver’s license, and a voided company check. The line of credit is renewed yearly at no cost and there is no obligation to use it.
If you would like to receive a no obligation offer letter to consider, please fill out the 2-minute application here. There is no credit check done for offer letters.
Remember, the time to get a business line of credit in place is when you don’t need it.