Finding cash to fuel growth and fund working capital is one of the biggest challenges faced by many small business owners. The media likes to write a lot about equity financing, but it’s not really an option for most small businesses. Angel investors and venture capitalists are usually only interested in companies that can scale quickly and generate a big payoff with an IPO (Initial Public Offering), purchase, or other similar exit—think Facebook or Twitter for example. That doesn’t usually describe the businesses you and I likely think of when we think of small businesses.
Even though the bank around the corner may have rejected your loan application, there are still options. They just might not be where you’re looking. But before we talk about the options, lets look at why the bank probably turned you down.
Don’t Let the Banker Give You a Vague Answer—You Need to Know Why
First, don’t let you banker off the hook. You need to know the real reason you were rejected. They might not want to share the reasons, but make sure they get specific. Was it your credit score, the industry you’re in, or something else? You need to know if your application was doomed from the start so you can make adjustments for next time.
Bankers don’t like anything that looks risky. Even though you may have a healthy business, there are a lot of factors that impact whether or not you qualify for a loan. If you have less that four or five years in business, the bank is probably not going to approve your application—even if your cash flow and other factors are good. Sometimes it isn’t really you or your business; it’s the bank. That said, sometimes it is you. If it is, you need to know what you can do to improve the odds next time.
Because roughly half of all great business ideas don’t make it to a fifth birthday, if you’ve been in business less than five years, what a banker sees when he or she looks at you is basically a coin toss as to whether or not your business will even be around at the end of the five-year term loan you’re applying for. If you’ve been around longer, it could be the industry you’re in, your credit score, or lack of collateral that could keep you from getting an approval on your small business loan.
Bankers want to know that you are able to repay a loan. That’s why they want to see time in business, a track record, and a healthy cash flow. They also want to know that if they approve your loan application, you’ll make regular payments—which is why they look so closely at your credit score. They also want to know that you have a plan if something goes wrong in your business. That’s why they want to see collateral. No banker wants to take your collateral— they want your loan payments, but if something goes wrong, collateral reduces the amount of risk and exposure to the bank. If you can show a lender that you are able to repay a loan, have a history of meeting your financial obligations on time, and you will still be able to make your payments should something go wrong, your odds greatly improve.
Traditional lenders like bankers want to collateralize small business loans to reduce the amount of their exposure and risk should you default. Since a banker can’t really collateralize a great idea, it’s difficult for them to offer you a loan based solely on your great idea or business. Nevertheless, there are other lenders that look at collateral differently than the bank.
If you’ve been in business for at least a year, have good revenues, a good reputation with your vendors, and a good personal credit score, there are options available. You might not find success with a five- or 10-year term loan, but you may find short-term financing to help you purchase equipment or buy inventory.
Earlier this year Wells Fargo announced it would be devoting more resources to small business lending. Good news for small business borrowers, right? If you have a good business and personal credit score, have collateral, and can demonstrate the cash flow to make the loan payments it could be great for you. If not, you’ll need to spend more time building a better credit profile—in other words, reduce the risk associated with lending to you.
Even if you’re not a startup anymore and have a few years under your belt, it’s standard practice for the banker to look at your personal credit history to get a snapshot of your credit worthiness. That’s great if your personal credit score is upward of 720, but a 650 credit score (or less) isn’t going to help you. And, even after you’ve been in business for a while, bankers want to know your personal credit score, so it’s very risky to ignore it.
There really aren’t any shortcuts to improving your credit profile, but with six months of focus on paying your bills on time and monitoring your credit score, you may be able to bump your personal score up as much as 100 points.
There are Other Options and You Need to Know What They Are
Bootstrapping is probably the way most Main Street businesses get off the ground and the way many businesses operate for years. It might not be the best way to encourage rapid growth, but for those with a “slow and steady wins the race” mindset, the more organic-feeling growth rate is appealing to many small business owners. Although most small business owners think of the bank when they need to borrow money, many business owners choose to invest personal savings or leverage cash flow to keep the wheels turning.
Friends and Family
Although friends and family isn’t the most popular place to look for funding, it’s still a viable option and where the vast majority of small business owners find capital—even businesses that have been around a while. In fact the success rate is better than grants, crowdfunding, credit cards, and other types of online and offline small business lending.
Your vendors want you to succeed almost as badly as you do. If you’ve been doing business with them for a while, stay current with your accounts payable, and are considered a good customer, it’s not uncommon for a vendor to offer special terms. Some venders will even set up a floor planning arrangement so you can stock inventory and pay for it as it sells. Of course, this isn’t something they will do if your credit is questionable or you don’t have some kind of track record with them. In many cases it might even be as easy as approaching a vendor to see if they regularly offer a financing program for their distributors. At the very least, it’s likely they can offer advice as to what merchandise you need to make sure you avoid stocking too much of the wrong stuff.
Personal Credit Cards
A lot of business owners leverage their personal credit cards to access capital for their business. Although this is a popular way to use credit, using your personal credit card over a business credit card probably isn’t a really good idea. Because credit card companies report to the credit bureaus at the time they invoice you, even if you pay them off immediately, it’s the amount of credit you’re using compared to the amount of credit available that impacts your score. Most credit card companies report on your personal credit report—potentially lowering your personal credit score.
Business Credit Cards
It makes sense to use a business credit card for business, but it’s important to make sure they report to the business credit bureaus. This will allow you to better manage your personal credit score in addition to you business credit score. It might even help you improve your personal score.
Crowdfunding is a relatively new way for small businesses to finance new products or even special projects. Basically you mobilize a group of people to donate small amounts of money toward a common goal, such as the creation of a new product in exchange for something of value, possibly early access to the product or maybe even equity in the company. Since it’s beginnings, crowdfunding has evolved to allow small equity investors to invest in your business ideas.
Depending on the type of business you’re in, how far along you are in developing your product, and your ability to “sell” your idea on one of the many crowdfunding platforms, it could be a good way for you to access capital for your small business.
There are also a lot of options available online for small business owners with at least a year in business (though there are some that will work with a newer business). Online lenders don’t typically hold you to the same rigid credit criteria a traditional bank might, but you’ll need to have some business history to find success with this type of financing. Factoring companies, merchant cash advance (MCA) providers, and other online lenders offer loan products designed to help small business owners that have been turned down at the bank access capital. Some are more expensive than others and terms vary from lender to lender, but a little homework will help you determine which of these loan types might be right for you and your business.
There are a number of resources available to help small business owners manage their business and improve their credit profile. Here are just a few:
In addition to resources offered by the SBA, SCORE has been providing mentoring and advice to business owners for the last 50 years. The SBA offers a lot of online information you can review at your convenience. In addition to what SCORE has online, you can also sit down and visit with an experienced business professional (often someone who has retired from a successful business) to talk with you about your business.
Dunn & Bradstreet, Equifax, and Experian are the three major business credit-reporting agencies and have lots of great information on topics like improving your credit score, collecting debt, regulatory compliance, and other credit and debt related advice.
Because your personal credit score is important at almost every stage of your small business—particularly during your first several years, you should also bookmark the three primary personal credit-reporting agencies, Experian, Equifax, and TransUnion.