5 Reasons Banks Are the Least Friendly for Business Loans
by Mashum Mollah Banking 18 January 2019
If you are among the many business owners who find it nearly impossible to arrange to finance through a bank or building the society, know that you are not alone. Retail banks tend to be the least friendly of all financial institutions when it comes to business loans. That is just the nature of the beast.
Having said that, it might be helpful for you to understand why retail banks are not very friendly to small business financing. It is not that they do not like businesses or business owners. Rather, it all boils down to risk. Lending is a risky business no matter who a bank lends to, so retail banks have to be intentionally risk-averse in order to protect themselves and their depositors.
Here are five reasons, all related to risk, that cause banks to be unfriendly toward business loans:
1. Tight Credit Restrictions:
Banks have always had to be concerned about the creditworthiness of their customers. However, credit restrictions were voluntarily tightened following the financial crisis of the previous decade. Banks now tend to go to much greater lengths to verify creditworthiness before they will approve a loan. That is hard enough to do when they are dealing with retail customers. It is even harder when they are reviewing business applications.
Rest assured that banks will check your credit history and score whenever you apply for business loans. If they find anything less than a stellar record, they will have to weigh their risk aversion against any potential reward. They will factor in the results of that comparison along with other things.
2. Time is Indicative of Success:
Next, time is indicative of success in a business setting. In more simple terms, businesses stand a greater chance of succeeding the longer they remain operational. The thing about business loans is that they are most often sought during the first few years of operation. As such, banks often do not have a long history of time to look at. That automatically raises the level of risk.
3. The Cash Flow Conundrum:
As a business owner, why would you seek funding from a bank? Probably because you have certain financial needs that can’t be supported by current cash flow. This creates a conundrum for banks. Banks are looking for sufficient cash flow as evidence that a borrower has the means to repay. Yet the reason the borrower has applied for business loans is related to limited cash flow.
Do you see the conflict here? Unfortunately for business owners, limited cash flow is almost always negative. Banks would rather be safe by not lending than sorry after lending to a business that cannot afford to repay.
4. Questions about Collateral:
Next, business loans tied to collateral give banks yet another reason to pause. Let’s say a business owner offers tens of thousands of pounds in equipment as backing for a loan. The bank has to consider how successful it would be selling that equipment in the event of default.
When you are taking a mortgage, there are fewer concerns inasmuch as it is fairly easy to sell a repossessed house. The market for repossessed equipment is another matter. Can the bank really sell a failed restaurant’s assets? Can it turn over a load of industrial equipment to cover a defaulted loan?
5. Banks Want Clarity of Vision:
The fifth and final reason relates to a business’s mission and vision. When you are talking about a new start-up, lenders are looking closely at that mission and vision to see where the business owner’s head is at. They do their best to determine if his or her mission and vision are reasonable.
When you’re talking about an existing business, banks are looking at how closely the company’s mission and vision align with reality. If they are not closely aligned, bank officers are tempted to believe that the applicant is not properly prepared to take on additional debt. This creates a commensurate increase in risk.
Business loans are hard to come by as it is. If you are looking to borrow, you’re probably going to find your bank or building society the least friendly of your options. Consider looking at a private lender or some sort of equity investment instead.