Often when a business borrower gets turned down for a loan they simply give up rather than learning from their experience. Instead of assuming of leaving with your tail between your legs, use the experience to improve your loan package.
First before you ever get to a “no” answer, understand how your bank makes a loan decision. How much authority does your individual loan officer have in the process. Will your loan officer be presenting your loan to a loan committee or an individual for approval? Don’t be bashful about asking your loan officer what the most important criteria is for getting loan approval. If your loan officer is a strong producer of loans for their bank, they won’t take on your request unless they have a strong belief that your loan will get approved.
If your loan doesn’t meet the bank’s lending criteria, your loan request will never make it to a loan committee or lending authority. Your loan officer can make the necessary calculations and should understand what the bank’s lending standards are. A quick no answer is much better than a slow, drawn out no. That way you can go back and make changes to your loan package and either go back to the same bank or be more prepared to move on to the next one.
In my many years of banking I have come to believe there are a few main reasons a loan request gets turned down.
- Sloppy loan application and supporting documentation. Attention to detail cannot be over emphasized. A completely filled out loan application and well organized set of loan documentation shows a lender you care about details. Details are what make good business people good. Discrepancies and errors make a lending officer worry that you make errors and don’t pay attention to detail in your business.
- Inability to support debt service. All lenders want and expect to be paid back. The mathematical formula for determining your ability to repay debt is called debt service coverage ratio (DSCR). Learn to calculate your business’ DSCR yourself. If it is at least 1.25:1 with the new loan added, you will probably meet most banks minimum requirements. The higher the ratio the better. A negative debt service coverage ratio means you don’t have enough net operating income to pay all your debt.
- Historical losses. Banks want to see that you have been profitable for at least the last two consecutive years. If the losses were called by non-operational reasons lenders will often take the amount of the non-operating losses and add them back, assuming they don’t think you will have the same kind of losses in the future. If your business can provide significant documentation that the losses were caused by development of new products or services, they are also willing to consider the amount of funds spent on new product development assuming that they can believe the new product or service will generate significant new revenues and profits moving forward.
- Banker doesn’t understand your business. A loan officer has to go to their loan committee or individual lending authority to explain your business and loan request. If they don’t understand it, they can’t explain it. A good rule of thumb is to think of it like this. If you have a complex business model, service or products, plan on explaining the business in an elevator pitch. If the loan officer can’t go home and explain your business to his or her wife or husband, chances are they can’t explain it to their loan committee.
Every now and then a good loan request simply gets turned down because the mood of the credit committee isn’t good on the day the loan is presented. I have seen this happen many times. If a loan committee is focusing its attention on working out loans that aren’t performing, they are going to be harder on any new loan requests. This isn’t something you can do anything about, but if you know that the loan was turned down because the loan committee was having a bad day, you can know that another bank might see the loan in a favorable way.