Recipe for Loan Denial

If you have decided to apply for a business loan, start planning ahead. Research widely on "friendly lenders" for the type and cost of funding. They may be banks, cooperative banks, angle investors, venture capitalists or other financiers. Lenders aim on minimizing risks to the bear minimum, hence the rigorous underwriting process. Take this process seriously, if you wish to get funded. I have put together here below some causes for loan denial.

1. Lack of preparation
If you approach a lender with a scribbled piece of paper and incoherent information on the business or strategic plan you will have very little chance of success. Plan ahead of time and gather all relevant information to support your loan request. Document all information in a logical and presentable manner. Seek professional help, if necessary but please do not walk in a lender's office without information on yourself, the business and a loan proposal. A loan proposal should indicate who the borrower will be, purpose and type of loan, amount, maturity, amortization, primary and secondary repayment sources, collateral to be pledged and guarantors. It is advisable to indicate the rate that you have used in your cash flows and financial projections.

2. Repayment plan
Always bear in mind that banks use depositors money for lending. Therefore they are required by law to protect those deposits through prudent lending. One sure way of protecting those deposits is to lend them to creditworthy parties that demonstrate ability to repay. If your loan application shows no repayment plan, it will create doubts on the lender's mind as to whether you are competent to manage the loan proceeds. Always indicate clearly the sources and uses of funds, sustainability of positive cash flows over the loan period and stress-test your assumptions

3. Inadequate Equity
Banks have varying requirements for owners stake or equity in the business. The reason why they require to see equity in the business is because equity provides cushion during lean times and it also demonstrates business owner's commitment to the success of the business. Equity contribution varies from bank to bank and sometimes on loan type. It ranges from zero to over 50%. Many lenders consider leverage and gearing ratios of 1:3 and 1:2, respectively as being ideal.

4. Inadequate Collateral
Collateral is key to lending despite many lenders' claim that collateral is the last criteria they consider when analyzing a loan request . Collateral shortfall is normally resolved by reducing the loan amount to achieve a loan to value ratio of a maximum of 85%. Some lenders may go beyond 85% but that is a violation of the regulatory rules. Different loan types require different collateral types. For example, a real estate transaction will be secured with real estate while a line of credit will be secured with receivables, inventory or machinery and equipment. That is, long term loans are secured with fixed assets with long useful lives and short term loans are secured with short term assets. Note that short term loans may be secured with term assets but long term loans should never be secured with short term assets.

5. Poor financial performance - recurring losses
Lenders are allergic to declining sales and income and go ballistic when they see a financial statement indicating losses over a three-year period or more. Before applying for a loan, you should thoroughly review your financial performance, troubleshoot the causes of poor performance and address them adequately. You cannot ignore declining trends by assuming the lender is aware of the unfavorable trading conditions in a declining economy, the troubles in your industry, or your emerging business

6. Lack of financial statements or current tax returns
Requesting for a loan without financial statements is unforgivable. As a minimum, always put together a package of business financial statements and/ or Federal Income Tax Returns (FITR) for the most recent three years, at least one year of financial statements and cash flow projections, your current Personal Financial Statement, your personal tax returns for at least two recent years, rent rolls and leases in case of commercial real estate, sources and uses of funds and the business or financing plan.
Without this information, a lender will not be in a position to assess your financial performance. Please seek professional help if necessary to get your loan request documentation reviewed, repaired and enhanced prior to submitting them to your bank. LoansUnderwriting.com provides such help.

7. Lack of business experience
We all know that one is not born with experience and one cannot buy experience, yet lenders insist on experience as one of the criterion for prudent lending . A lender views lack of experience as too risky and a sure way of defaulting owing to funds and business mismanagement. It is difficult to find a balance on this issue because almost everyone starts without experience unless they already are operating a similar business. Be ready to explain yourself and mitigate this perceived risk intelligently. A lender may ask the borrower to pledge additional collateral and/ or contribute additional equity.

8. Business track record
Just like lack of business experience by the owner, equally lack of business track record is perceived too risky. Lenders try to avoid start-ups because, let's face it, anything can go wrong with the business from day one. A track record provides the lender a kind of history on performance and how the business survived bad times in the past. If your business is a start-up or emerging, you should prepare an elaborate business or project plan based on sound assumptions that can be tested and win a lender's confidence.

9. Lack of a clear source of repayment or adequate cash flow
This is simple common sense. If you borrow money you will be expected to pay it back from some source. The repayment source must be identified at the application stage. Business loans are normally paid from continuing cash flow, i.e. business operations of the borrowing entity or a related entity that will be required to guarantee the loan. Other sources of cash flow are sale of assets, gifts, savings and marketable securities to name a few. Lenders' preferred sources are business operations and cash liens. Now you know why a loss making business is not a darling of lenders.

10. Bad Credit history of principal or borrower
Many business owners ask me why lenders insist on analyzing personal credit history when assessing a business loan request. The principal behind the analysis is that, as the business owner one must be a good manager of one's personal finances to earn the trust of managing borrowed business funds. After all, there is always the risk of the principal using business funds on personal endeavors. Therefore, you should check your credit report often for erroneous entries that could ruin your credit.

11. Unfavorable trading conditions
During economic downturn, lenders tend to scale down lending because many businesses rarely survive economic downturns. With a declining market and low demand, it is not surprising that small businesses experience drop in sales and profitability. Therefore, the highly leveraged ones end up defaulting on loan payments and eventual fold. Lenders are abundantly aware of this, hence the cautious approach of scaling down loans. Unfavorable trading conditions and industry decline are other causes for loan denial.

12. Lack of professional help
Many business owners do not appreciate the role of professionals in getting them funded. Understandably, it is a matter of saving every penny particularly during these lean times. However, the cost of not getting funded or getting funded late can be devastating. A company that runs out of cash is likely to be faced with employee unrest or creditor lawsuits and further exacerbate the cash flow crunch. If you are not sure of how to package a loan request properly, get professional help. It will be money well spent.
Authored by: Frank Kigondu
[http://www.loansnderwriting.com]