The Risk Factor: Why You Can’t Seem to Get a Small Business LoanAugust 22, 2016 / byArs Lexis / Categories : Financial Sense
Why does a small business have it tough when securing a loan? Put simply, it all comes down to risk. The model for lending is really simple; interest from payments should be higher than the possibility of the borrower defaulting on the loan. The big questions is: How do banks calculate “risk”?
- The business’ industry – While only around 50% of small businesses continue operations five years from the time they started, failure rate significantly differ by industry such that a doctor’s office has a higher survival rate than a restaurant.
- Financial ratios – This includes profitability and solvency or cash flow. Does the small business have ample profits to ensure timely loan repayments? Solvency, on the other hand, represents the small business capacity to use current liquid assets for repaying their existing liabilities.
- Years in operation – A business’ survival rate increases significantly with time. This means that a business that has been in operation longer has a lower risk of default. If you’re planning to take a small business loan in Bloomington on your fifth or eighth year, don’t be afraid to do so.
- Credit history – The bank will first check your business’ credit history in relation to their vendors and banks, and then take a look at your personal credit.
- Tax liability, liens, and lawsuits – It’s crucial for banks to ensure that your business doesn’t have potential or current lawsuits and outstanding liens that could potentially put your business at a risk financial situation. This holds especially true for IRS liability.
- Personal guarantee – Banks will determine if you or your loan guarantors believe in your business that you or your guarantors will take full responsibility for loan payments in case your business goes under water.
- Purpose of the loan – Basically, banks will want to ensure that your loan purpose is sensible. For instance, if your borrowing money to buy costly equipment that could potentially last between five and seven years, then apply for a loan with a term of five years is sensible.
As you can see, qualifying for a loan requires ample preparation and a strong strategy so that your business will come across a lendable and low risk to banks. Consult your CPA, fix your personal and business credit, and ensure that you have strong relationships with your current banks to increase your chances of securing a loan for your small business.