Capital — it’s the one thing small businesses need the most, but it’s often the hardest to come by.
That’s because lending standards remain tight six years after the 2008 recession. Among all small businesses, 82% were denied financing by their bank last year, according to the 2013 Main Street Pulse Report by small business lender OnDeck. At a minimum, bankers want to see a detailed business plan, a profitable business that demonstrates the ability to repay a loan, a strong business credit score and a detailed credit policy.
You don’t have to be one of the many businesses that face being rejected for a loan. Here are five ways to avoid being turned down for a small business loan.
1. Come to the table organized
If you approach a lender organized and prepared with all the required documents in hand, it demonstrates that you are serious and have put in the necessary time and effort to correctly apply for the loan.
While the required documentation differs from lender to lender, it’s likely you will have to provide the current financials of your business through profit and loss statements; a balance sheet that lists your company’s assets versus its liabilities; three years of tax returns (if you’ve been in business that long); or the last tax returns you’ve completed, says Craig Smalley, a small business lending expert.
Other documents that may be required include bank statements, legal documents such as your business license and registration, articles of incorporation and commercial leases.
Failing to provide the lender with documents in a timely manner could result in a delay, or even the rejection of your loan application from the get-go. So it pays to be organized and get the ball rolling sooner rather than later.
2. Improve your cash flow
Banks want to see that your business has the ability to repay the loan, producing enough cash flow to comfortably pay off the debt and cover any regular expenses.
How can you improve your cash flow without actually increasing sales? Try getting paid from your customers sooner by offering an early pay discount on outstanding invoices, says Michelle Dunn, an author and expert on credit and collections.
“For example, if you have a customer currently paying you back in 45 or 60 days, you can offer shorter terms at a discount so you end up getting paid sooner, which means more cash in the bank now rather than later,” Dunn says.
The discount can be anywhere from 3% to 5% of the invoice, she says. So on a $10,000 invoice that is normally repaid in 60 days, you might offer a $300 to $500 discount if it’s paid off in 15 days.
“Big businesses will pay people who offer them an early pay discount first, rather than pay people who just offer regular terms,” Dunn says. “Because in one year, that can add up to hundreds, if not thousands of dollars in savings to your customer.”
For you this means more cash in the bank to pay the bills, early repayment on any outstanding debts to improve your balance sheet, and the chance to show the lender that you not only have strong sales, but also that you can successfully collect unpaid invoices from customers in a timely, professional manner.
3. Strengthen your business credit score
Did you know your business likely has its own credit score? Just like a personal credit score reveals a person’s risk of repaying a loan, a business credit score or a Paydex Score does the same for a business.
Banks likely won’t check your personal credit score in the loan application process unless your business is new and does not have established credit, or unless you’re in business as a sole proprietor, says Deirdre Morhet, a small business accountant, tax preparer and founder of BASC Expertise in Mesa, Arizona.
First, find out what’s in your business credit reports. It should include information like your company’s payment record, total debt, the number of loans you’ve applied for recently and the length of time you’ve had credit available. Examine this information carefully, because there could be errors that are bringing your score down, including late payments that were actually made on time, or liens or judgments that were resolved or don’t even exist.
You can get a copy of your report from Dun & Bradstreet, Experian and Equifax. If you find errors on your report, you can dispute them online or by phone, as long as you provide the correct information with supporting documents that prove the error.
Also, try not to rack up any additional business debt during the loan application process, as this can have a negative affect on your score and might not sit well with lenders, according to Morhet.
“If you’ve maxed out your credit accounts, it shows you won’t have any money left over at the end of the month to repay the loan,” Morhet says. “So the more you can pay down and have available credit on your report, the more it shows the bank you can afford to take on the loan.”
4. Present a detailed credit plan
A business plan shows how you plan to grow sales. But your credit plan or policy outlines which customers you’re going to extend credit to, how much credit you’ll give them, how you’ll be paid, and what will happen if you’re not paid on time and in full, according to Dunn.
“It tells the bank you are going to get all these new customers, but you’re going to make sure they’re creditworthy before you ship them anything, because you want to get paid and you want to get this loan,” Dunn says.
How can you put together a solid credit policy if you don’t have one yet? You can start by crafting a mission statement for your policy, just like the one you have for your business plan. It should say what you want your credit policy to do for your business, according to Dunn.
“It can be as simple as saying your credit department will offer credit to all customers that fill out an application and are found creditworthy,” Dunn says.
Next, develop the policies and procedures that will govern your credit policy. This will include your payments terms, credit limits, how credit applications will be processed, and what will be done if one of your customers is late making payments.
“It might say that everyone who comes 30 days past due receives a phone call or a letter from someone in accounting,” Dunn says. “And if they don’t pay you, you’ll tell the bank what you plan to do to limit your risk and recover the money.”
5. Cultivate a relationship with the lender
Banks are more likely to lend money to your business if they know and trust you.
“It definitely helps and makes it easier to have an existing relationship,” Dunn says. “It’s just like your customers — they want to do business with people they know.”
Think about it: If the people at the bank get to know you and your business, they might feel more comfortable extending you credit. So be as friendly as possible.
Consider signing up for a business credit card through the bank, or moving a personal checking or savings account to the bank. If the lender sees that your business is doing well and you have had no problem repaying a credit card or another loan with the bank, it should work to your advantage.
What if you follow all these steps and still get turned down for a loan?
“Don’t get discouraged,” Morhet says. “Just because one lender turns you down, it doesn’t mean that you are not a good candidate for a loan. You just might need to find a new lender who is willing to work with you.”
For more information on small business financing and getting your business started, check out NerdWallet’s Small Business Guide.
Rejected credit application via Shutterstock.