One of the top misconceptions about SBA loans (such as 7(a) loans, not emergency or disaster loans) is that they aren’t for “successful” companies. In reality, SBA loans are for solid small businesses and promising start-ups that may not meet all of the criteria for a conventional business loan. There are several reasons a business may not qualify for conventional credit, and some of them are more complex than meets the eye.
We want to shed light on the reasons that successful and bright-futured businesses can have challenges obtaining conventional credit.
A lender’s calculation of risk can be made of both objective and subjective criteria. Financial statements and credit history provide hard data, but factors such as a business owner’s management experience, market conditions and forecasts, and a lender’s understanding of the industry can also play a part in willingness to extend credit.
The perception of risk can be a significant barrier, even for businesses with a good historical track record. We have noted from our own observation and experience in business lending that as commercial real estate loans have become more favored in the banking community, lenders have lost a certain degree of expertise in making commercial and industrial loans and the lack of industry experience makes them perceive C&I loans as more risky. This concept can apply in other areas, too.
Lenders’ natural instinct during an uncertain economy (like an ongoing global pandemic, for example) is to tighten credit standards almost universally. As they become more cautious about extending credit, businesses that can’t meet heightened standards for down payments, liquidity, and debt-to-equity ratios can get shut out. So while the top echelon of companies can access capital – a significant percentage of businesses remain underserved, due to forces that are largely beyond their control.
When a business needs a loan that will not be secured by commercial real estate, collateral can quickly become an issue. Though each lending institution has its own policies around acceptable collateral, there is often a strong preference for real estate. Specialized equipment can be difficult to liquidate, and companies that need to fund working capital or technology have little with which to secure a loan. This can be especially problematic for new businesses that need to fund start-up costs.
Limited Business History
New businesses, even those with a great business plan, or an experienced management team, still lack the record and historical financials that help boost lender confidence. Even more so if the business is in a new or emerging field. Most entrepreneurs – even those that have gone onto great success – have cited financing as their biggest business challenge.
A Recent Bad Year
Even highly successful businesses go through rough patches. An obvious example are the millions of longstanding businesses that have been abruptly and severely disrupted by the COVID pandemic, through no fault of their own. But even during more normal times, the economy goes through cycles that may cause a business’s revenue to temporarily contract. This doesn’t mean that the business has a risky outlook, especially when there’s strong evidence of good management practices. But still, if a business finds itself in need of financing to fuel growth after a downturn, it is likely to experience stronger headwinds in the lending market.
Businesses are routinely turned down for loans for any of the above reasons, but it certainly doesn’t mean they aren’t credit-worthy or financially sound. Under Armour, Chipotle, and even Apple were small businesses once … and they all received help from the SBA! Instead of turning them away, turn them into loyal customers by supporting their business with an SBA loan.
If your bank has been hesitant to make SBA loans because you think they are for troubled credits, we’d love to share many compelling stories of businesses that have achieved, maintained, and grown their success with help from an SBA loan.