Five reasons business loans are declined

“2021 has seen a lack of lending appetite among the main High Street lenders due to the ongoing uncertainty caused by the pandemic,” says Rob Warlow, founder of SME loan broker Business Loan Services. “2020 saw businesses gorging on debt provided by lenders under the Bounce Bank Loan and CBILS. It is this debt hangover that is now concerning both businesses and lenders alike.”

With the economy now opening up, many SMEs will be faced with the challenges of securing access to working capital in order to fund their day-to-day cashflow needs. In certain cases, this is going to be a struggle and could cause an increase in the number of firms entering into some form of insolvency arrangement in the remainder of 2021 and into 2022.

For those SMEs looking to borrow, Rob’s hottest tip is to start the process early, ideally six to 12 months in advance of submitting an application. This will allow time to research all options, target the most appropriate lenders and tailor the business and loan application so that the chances of success are maximised.

Below, Rob shares his thoughts on some common reasons why loans are declined, and how SMEs can avoid this fate:

In recent years, two very distinct groups of lenders have emerged: banks and ‘fintechs’. Traditional banks now mostly avoid small loans (as a rough rule of thumb, below £25,000). Meanwhile, fintechs, such as peer-to-peer lenders, dominate this end of the market.

Banks have more manual loan-application processes (in a low-interest-rate environment, small loans are simply uneconomical for them), while fintechs tend to have highly automated online processes that are strictly ‘rules based’.

So, SMEs need to target lenders that are comfortable with the size of loan they need.

It is also important to find out which lenders are active in your sector. In the current climate, banks and other lenders are avoiding or are being ultra-cautious about some areas – for example, understandably, obtaining finance can be quite difficult now for high-street retailers, restaurants and the leisure sector, which have seen higher levels of stress as a result of COVID-19.

It is worth having an early conversation with target lenders to make sure they are active in your sector.

Because of their automated processes, credit scores are especially important to fintech lenders. Banks will sometimes dig deeper into the reasons behind a low credit score, but an automated process just looks at the score itself and a decision is made.

Businesses therefore need to make sure they maintain a healthy credit history. Some of the common causes of lower credit scores include: late or last-minute filing of accounts (there can be a few days’ delay between when accounts are filed and when they are available for credit-scoring algorithms to read, so the algorithm may assume accounts are late if they were only filed at the last minute); late payment of invoices (reporting late payments to credit-scoring agencies is becoming more common – this puts a black mark against the name of the late payer); and judgements or payment defaults against the company (a CCJ has a significant negative impact on a credit score).

The personal credit history of directors and large shareholders is also important. Lenders will often be relying on the personal guarantees of directors and will want to make sure they are in a solid financial position.

The financial impact of the pandemic will now be reflected in firms’ 2020/21 annual accounts, so we can expect a further downgrading of credit scores, which will negatively affect the ability to raise finance and/or the cost of funds.

Especially in the case of larger loans, lenders will be studying certain financial metrics. They will look at how profitable, or otherwise, the business is. With the increased level of debt businesses have taken on over the past 18 months, the ability to generate enough cash to easily cover Bounce Back Loans, CBILS and the proposed loan repayments will be a key factor. The overall burden of debt on a balance sheet will be the lender’s main concern.

In the current climate, lenders will expect to look at the very latest annual accounts; waiting right up until the filing deadline will not be acceptable. The expectation will also be that up-to-date management accounts are presented with an application. Annual accounts are seen as historic, hence the need for current-year trading information.

An additional point businesses need to look out for is that sometimes accountants will (quite legitimately) structure the financials to minimise profit (and consequently, tax). But this can work against a favourable lending decision. Planning ahead and structuring the financials to suit a loan application well in advance will be necessary.

Particularly for loans above the ‘automated’ assessment threshold, lenders will be studying bank statements and reject applications where repeated patterns of bounced cheques or unplanned overdrafts are evident.

Start-ups are generally a no-go for debt finance, due to their higher risk and lack of trading record. As a rule of thumb, debt finance can be considered after 12 months of trading history has been established.

A final point Rob flags for SMEs is that although the government has launched the Recovery Loan Scheme, which provides an 80% guarantee to lenders, this additional support will not change how lenders review an application; they will still apply all the usual rules when it comes to making a decision about whether to support the request or otherwise.

The final message is to be fully prepared before approaching a lender for finance.