Education Library · Foundations · Article 6
An auto repair shop owner had just finished his first year over $1 million in revenue when he applied for a long-term loan and got declined. Asked later what the reason was, he said, “because we had four, four MCAs.” The lender didn’t want to come in behind four merchant cash advances that already had first claim on the shop’s revenue. Sales, years in business and the quality of the work never really entered into it.
Most declines work like that. A lender runs the application against a list of things that can end it, and one item on the list is usually enough. Owners tend to hear “no” as a verdict on the whole business, when the actual reason is usually narrower than that.
The common reasons
Time in business. Many banks want to see at least a couple of years of operating history before they’ll make a conventional loan, and some want more. A young company can have strong revenue and still not get past the first screen.
Tax returns that show little income. Banks underwrite from tax returns. An owner who writes off the trucks, the equipment and every expense the CPA will allow pays less tax, and the return shows a business that barely made money. The lender takes the return at face value. How to balance tax savings against showing income is a question for your CPA.
Debt that pulls daily or weekly. Merchant cash advances and some online loans take payments out of the bank account every business day or every week. A bank sees every one of those withdrawals on the statements. Many won’t lend behind them, especially when that other lender holds a lien on the business’s receivables. Two or more stacked together is one of the most common reasons a refinance gets turned down.
Low balances, dips and overdrafts. Lenders look at the average daily balance, how low the account gets, whether deposits are steady and whether there are NSF or overdraft charges. A construction owner doing around $900,000 a year was declined for a line of credit because the lender flagged months where deposits dropped. He had over $40,000 in invoices out at the time and showed them the list. His take afterward: “it was just a matter of, like, customers being late, right, which is just sometimes a fact of business.” The lender was looking at the deposits that had landed, not the ones that were coming.
Cash flow that doesn’t cover the payment. Lenders compare the cash the business has available to pay debt with the debt payments it would have, new loan included. That comparison is the debt service coverage ratio. If a business has $150,000 a year available after expenses and owner pay, and its loan payments with the new loan would total $140,000, the ratio is about 1.07. Each lender sets its own minimum, and nearly all want some cushion above 1.0, so a business can be profitable and still not fit the payment.
Personal credit. For most small businesses the owner’s personal credit is part of the decision, and sometimes the deciding part. FICO says inquiries make up about 10% of a FICO score and that one more inquiry usually takes less than five points off. Some lenders also look at the number of recent applications on their own, separate from the score, so several applications in a short stretch can hurt more than the points suggest.
Industry. Lenders treat some industries as higher risk, and the bureaus file every business under an industry code. A roofing company doing several million a year was declined on two business credit applications. When its business credit reports were pulled, one bureau had the company listed as a full-service restaurant, an industry lenders see as high risk. That code may not have been the only reason, but it was wrong, and a lender’s system would have read it as fact.
Collateral and liens. Larger loans usually need something securing them. If an equipment lender or a cash advance company has already filed a UCC lien covering all business assets, the next lender may have nothing left to take as collateral, or may only be able to sit behind the first one.
The adverse action notice
When a lender declines a business credit application, the Equal Credit Opportunity Act and its rule, Regulation B, generally require it to tell you. The details depend on the size of the business.
If the business had gross revenue of $1 million or less in its last fiscal year, the lender has to notify you within 30 days of receiving a completed application. The notice can be oral or written. It has to either state the specific reasons or tell you that you have the right to ask for them. If you ask within 60 days, the lender has 30 days to give you the reasons.
If the business had gross revenue over $1 million, the lender has to tell you about the decision within a reasonable time, orally or in writing. If you ask in writing for the reasons within 60 days, the lender has to give you a written statement of them.
The reasons are supposed to be specific. Under Regulation B, saying you didn’t meet the lender’s internal standards, or didn’t reach a qualifying score on its scoring system, isn’t enough. If the notice names a credit bureau whose report was used, you can generally get a free copy of that report from the bureau if you ask within 60 days. For questions about whether a lender followed the rules, talk to an attorney.
Owners often guess at the reason and guess wrong. A written reason gives you something concrete to look at.
One no isn’t every no
Every lender has its own criteria. A large bank’s automated system, a community bank, a credit union, an SBA lender, an equipment lender and an online lender can each look at the same business and come out differently, because they set different minimums for time in business, credit score, revenue, industry and collateral.
Some reasons travel with you, though. Stacked daily payments, a tax return showing a loss, a wrong industry code or a lien filed against all business assets will look the same to the next lender. Applying at ten more places that week adds inquiries without changing anything on the file. The reason for the decline is what tells you whether to try somewhere else or fix something first.
This article is educational and isn’t legal, tax, accounting or lending advice. Program rules, lender terms and credit bureau practices change, so verify current terms before acting.
Command your own path.