Rising competition, narrow profit margins, and changing business landscapes make small businesses need help to stay afloat. There may come a time when small businesses need higher funds to pursue growth or to tide over tough times. This is when small business owners apply for a business loan.
However, securing financing is often a hurdle for these businesses, with loan rejections being a common occurrence. Understanding the reasons behind these rejections is crucial for businesses seeking to improve their chances of obtaining small business loans. This blog post will delve into the key factors that often lead to the rejection of small business loan applications in India.
What are the Reasons for the Rejection of Business Loan Application?
Let us look at the top 6 reasons for the rejection of small business loans in India:
1. Low Credit Score
One of the first things banks check is the credit score of the applicant business and its directors/promoters. The credit score gives the financial institutions an idea of how well the business has managed its past debts and bills.
Most lenders view a credit score below 700 risky. The loan application will most likely be rejected if the business or its directors have a poor credit history marked by delays, defaults, or written-off debts.
Before applying for a loan, small business owners must check their credit score and take necessary measures to improve it. Maintaining good credit behaviour, like timely bill payments, can strengthen the business' credit profile.
2. Unrealistic Business Plan
A solid business plan is your loan application's backbone. Financial institutions seek realistic projections and detailed operational plans. Convince them of your business's potential and secure the funding you need.
Unrealistic business plans can deter lenders. Avoid inflated projections, underestimated expenses, and implausible growth targets. Conduct thorough market research and competitive analysis. Be realistic, detailed, and conservative in your planning.
3. Inadequate Documentation
Not providing the required documents can also lead to loan rejection. Lenders need documents related to business registration, finances, compliance, and KYC papers. Failing to submit any of these makes the application incomplete, forcing the financial institution to reject it.
Small business owners must find the documentation the bank needs beforehand and furnish all supporting papers. Maintaining updated records also enables quick document submission.
4. Early Stage Businesses
While established businesses enjoy lower loan risks, startups can still access funding. By presenting a compelling business plan and demonstrating scalability, early-stage businesses such as startups can attract specialized lenders willing to invest in their potential.
5. Financial Integrity and Risk Assessment
When evaluating loan applications, banks and financial institutions prioritize assessing the financial integrity and risk profile of the business and its key personnel. This includes a thorough review of criminal records, past loan history, and any instances of financial misconduct. Such information helps lenders gauge the likelihood of default and make informed decisions about loan approval.
Tips to Improve Your Chances of Getting a Small Business Loan
Here are some key tips to improve your chances of securing a small business loan:
1. Maintain a Good Credit Score
Lenders consider credit scores when evaluating businesses and their owners. Generally, a score above 700 indicates responsible management of past debts. Small business owners should prioritise timely bill payments and clear outstanding debts to improve creditworthiness.
2. Create a Realistic Business Plan
A solid business plan helps the bank see the potential success of the business. It should include financial projections, market analysis, and detailed strategies. Avoid overly optimistic estimates and work with professionals to make the plan credible.
3. Ensure Complete Documentation
Incomplete paperwork is a common reason for loan rejection. Before applying, small business owners should gather all necessary documents, such as KYC, business registration, financial statements, and proof of address. Keeping records updated will make the process smoother.
Summing Up
Rejection of a small business loan can hamper growth plans and cash flow of small businesses. By understanding the reasons that can cause rejection, small businesses can take corrective actions and improve their loan acceptance chances. Maintaining financial discipline, planning pragmatically, preserving a good credit record, and timing application for a small business loan are critical success factors. Choosing the right bank partners is also crucial for small business owners in India seeking financing for growth or business continuity.
FAQs
1. Why are small business loans rejected?
Small business loans often get rejected due to low credit scores, unrealistic business plans, inadequate paperwork, lack of collateral, new businesses without financial history, or owners with criminal records.
2. Why do small companies struggle to get loans?
Generally, smaller businesses usually need help to get loans because they have limited operating history, lower revenues, higher risk, less collateral, and need to meet all eligibility criteria set by banks.
3. Why do banks and financial institutions ask for collateral while lending to small businesses?
Lenders secure collateral to mitigate risks, allowing them to recover the loan amount by liquidating assets if the business cannot repay the loan.
4. How can small business owners improve their credit scores?
To demonstrate financial discipline, small business owners can pay all bills on time, clear outstanding debts, avoid unnecessary loans, review credit reports regularly, and maintain low credit utilisation.
