Truth behind why SMEs face business loans rejection in India

So, you applied for small business loan and the bank declined your loan application? Business loan rejection is not an unheard of situation, especially for emerging businesses, MSMEs, and start-ups. Banks and non-banking financial companies (NBFCs) often reject business loan applications when they feel the risks of non-repayment are higher. So, how do you ensure that you are not denied business loan?

Do you consider government loan schemes for small businesses only? Or consider funding options from friends and family? Or even fund business with your personal savings (not recommended)? What if you can design a strategy to lower your chances of business loan rejection?

Let us look at the reasons why your loan application can be rejected, corrective steps and what you can do to ensure non-rejection in the future.

Understand why your loan application was rejected

When it comes to small business lending, there can be several possible reasons why your loan application was not approved.

• You/your business did not meet the minimum loan eligibility criteria
• Your personal credit score is low (i.e., less than 750)
• The loan amount requested is too high for your business
• You have multiple other loans/EMIs running simultaneously
• You do not have a collateral/guarantor to pledge for you
• Your business financials are not healthy
• Your business falls under the list of restricted/unserviceable industries
• Your business hasn’t been functional for long (at least 2-3 years)
• Your loan application documents are not consistent or are insufficient

It’s an endless list. What you need to understand is that the loan application gets rejected based on multiple parameters. The bank/NBFCs will evaluate your potential to repay and the risks associated with lending to you. If they feel that the possibility of defaulting is high, your business loan application will be declined.

Identify the areas of immediate and long-term fix

The next step you should take is to identify which areas of rejection can be fixed immediately (i.e., within 3 months) and which areas will take longer to fix. This will help you to prepare for your next loan application.

Business loan application rejection areas you can fix immediately:

Applying for the wrong kind of SME loan for your business:

Did you know, banks offer different kinds of SME loans depending on what you are seeking loan for? For instance, if you want to purchase a new vehicle (e.g., trucks, vans) for transportation of goods or for services, there are commercial vehicle loans available you can get?

Similarly, there are loans for working capital, machinery purchase, inventory purchase etc. As such, if your loan was rejected because you applied for a different type of loan than what you needed, this can be an immediate fix.

Having a low personal credit score:

Your personal credit score or creditworthiness can be a reason for loan rejection – and this is something that you can fix immediately.

Start by checking what’s your current score (e.g. 620+). Next pay off your credit card bills, EMIs, etc. on time and do not default on a single payment. Also, check to ensure that no errors have been made in your CIBIL report. If errors are there, ensure to get it fixed at the earliest. While your personal credit score will not change overnight, you will notice gradual improvement in time.

Requesting for a high amount loan than eligible:

If you are seeking a loan for your business, ideally, the first thing you should check is how much loan amount you are eligible for. For instance, you may be requiring a funding of ₹50 lakh, but are you eligible for it? What if your business loan eligibility is for ₹40 lakh only?

In most cases, there is a loan eligibility and EMI calculator available online (and offline) that will tell you how much you can borrow. This is based on your business’s financials, potential to repay, your own credit score, and multiple other factors. So, if your loan was rejected because you applied for an amount higher than you are eligible for, this is an area you can fix immediately i.e., reapply for a smaller amount loan.

Pro tip: It is always a good idea to prepare and share a comprehensive business plan with your loan application. A business plan outlines end-to-end details about your business and how the funds will be spent. For instance, it talks about the market, competition, product portfolio, financial forecast, current revenue, marketing/sales strategy for growth, customer profile, market segments, turnover, cash flow, management team, possible risks and solutions, and more.

This gives bank the confidence that you are aware of the challenges in the market and have a solution for it. This reduces the chances of your business loan application rejection.

Business loan application rejection areas you can fix in the long term:

Having poor P/L and financial statements for your business:

If your balance sheets and P/L statements are not healthy, it can be fixed in the long run. Most banks request for business’s financial statements (CA audited) and balance sheets to evaluate profits. A steady, consistent turnover growth record builds confidence, whereas fluctuations in earnings raise doubts. If you don’t want a loan rejection by banks/NBFCs in the future, work on building strong financials for your business.

For instance, try to upsell and cross sell to existing customers, follow up for payments relentlessly, identify areas that can be outsources for cost-efficiencies (e.g., logistics), cut down additional expenses, etc. This will prove to banks that your business is running steadily, your earnings and cash flow are healthy, and customers and profits growing.

Falling short of the minimum business vintage criteria:

This is one of the most common grounds for business loan rejection especially for new businesses and start-ups. Most banks and NBFCs check the business vintage of your enterprises.

A minimum of 2 years of successfully running your business makes you eligible for loan application and consideration. The vintage of your business gives banks the confidence that you will be able to run in the future and not shut down. As such, if this is the ground for loan rejection, the best thing to do is to wait and in the meanwhile build a strong financial health for your business.

For those looking for start-up and new business loan, consider using a collateral. While banks may still deliberate over giving you a loan, the chances are higher of not being denied outright.

Repaying multiple loans and EMIs simultaneously:

Consider pre-payment options if you can. Banks follow a simple rule for first-level loan evaluation. They check if you have existing loans and EMIs running, and if more than 35% of your income is spent on repaying existing loans. This is reason enough for them to not consider your loan application and deny loan to your small business.

In this situation, consider if any of your existing loans can be paid off early. There will be some pre-payment charges you will have to incur but you will be debt free sooner.

Find solutions: What you can do instead

If your preferred bank has rejected your loan application, consider alternatives. While shortlisting between banks/NBFCs for your loan, you must have shortlisted several. If the first lender declines your loan application, consider approaching others. You will be surprised how different lenders evaluate your loan application.

For instance, if you are looking for business loans for up to ₹50 lakh, consider Business Loans through Tata nexarc. We have partnered with trusted lenders and can help you get collateral-free loans at low interest rates online. Documents required is minimum and you can get a loan offer in as less as five minutes.

Apart from considering other lenders, consider other financing options, such as:

• Invoice financing: Applying for a loan against your approved invoices at a certain charge/fee/interest
• Line of credit: Getting a loan, but using funds when required
• Business credit cards: Using a credit card for your business, helping your business earn business credit in the long run (note – this is not typically a loan but a smart way to fund your business)

Understand that when lending, banks will want to ensure their safety. As such, if they find any grey area in your application, your loan request will be rejected.

So, before you apply, think as a banker would. Identify the loopholes and weak spots in your application. Also, prepare to negotiate a business loan offer if your application goes through.