We hear it all the time, frustrated entrepreneurs say things like:
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“The big banks aren’t lending to small businesses”
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“The banks aren’t willing to take a risk”
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“Why do banks even advertise small business loans? They don’t approve anyone!”
It is easy to blame the stingy, greedy bankers for your company’s inability to raise capital, but I think it is helpful to put yourself in the banks shoes sometimes in order to understand why they may not approve your company for a loan. Here are 3 reasons that cause your banker to seem stingy when it comes to your loan request.
1. They can only be wrong 1% of the time
Several months ago the Washington Post reported that delinquency rates for small business loans were down to the lowest level since 2005. The report showed that only 1.18% of business owners were behind by a month or more on their loan payments. This really puts things into perspective. For a bank to stay competitive, they must be right 99% of the time. If they think that there is a 5% chance that you will default on your loan request, then you are far too risky. One thing to keep in mind is that banks are not coming up with cash to lend to your business out of thin air. They are lending other people’s money. You wouldn’t want your bank to gamble on risky loans with your checking account deposits, so you must expect the bank to be tough on you.
2. There are simply better options
Another unfortunate reason that the banks seem to be ultra-conservative when it comes to small business lending is because there are simply better options out there. Banks want to lend, truly they do! The bank can’t make a profit if it does not lend and earn a return on your deposits, so if your business loan request is denied, it is because there are probably better, safer options for the bank. It is hard to make a loan to a small business that is just trying to make payroll next month, when there is an established business with a diverse customer base, growing market and a rock solid balance sheet down the street that needs a line of credit.
3. There is very little upside, but a lot of downside
Banks are not investors. Investors have the ability to reap reward when your company is wildly successful, but a bank is only going to recoup the principal and interest on your loan if you are successful. If you grow sales by 1,000% this year, your bank will still receive between 4% and 8% interest on your business loan. If the business fails though, the bank may lose everything. For this reason, the bank is going to do everything it can to protect against downside risk. That is why they will require more collateral than the value of the loan, because they need to protect the bank and the bank’s depositors.
At the end of the day you can’t blame the banks for being reluctant to lend to small businesses. You might be able to blame the marketing department for the commercials that make it seem like they want to fund small business, but you can’t blame the underwriters. Banks are in the business of renting money for a period of time and they want it back, in fact they need it back. If you understand this before you walk into the bank with your loan application, you will avoid much frustration, and you will be able to prepare your loan application to appeal to that stingy banker down the street.
Adam Hoeksema is the Co-Founder of ProjectionHub which is a web application that helps entrepreneurs create financial projections without the need to have a PhD in spreadsheet modeling.
