Why is it so difficult to get a bank loan for your small business these days?
The short answer is risk.
As someone who has worked in banking for many years and managed countless small business loan requests, I understand the mind of a lender. As such, I’m here to highlight exactly what bankers are looking for and to walk you through the best ways to convince them to lend you capital. But first, let’s start with the basics.
Why Is It So Hard to Get a Loan?
The lending business model is simple. Interest rates earned from the loan payments must be higher than the probability of the bank not getting paid back. For example, if the bank deems that there is a 20% chance they will not get their money back, they must lend you the money at 25% APR in order to protect their risk.
The problem is that 25% interest is considered usury in many states and is therefore illegal. To be able to lend to a small business at a more reasonable rate of 6% to 9%, the bank must be at least 95% sure that the loan will not default. Now do you see why it’s so difficult for small businesses to get loans?
While it may feel impossible, the fact is that some small businesses do receive bank loans. So what’s their secret? How does the bank achieve 95% certainty?
The banks arrive at this number by measuring different elements that contribute to default risk. Their goal is to make sure all signs point to the business succeeding and generating a reliable source of revenue.
The Lender’s Checklist: 10 Things They’re Looking For
There are 10 common areas of focus that banks measure to determine default risk:
1. The industry the business belongs to. Although only 50% of businesses make it past their first five years of operation, this failure rate varies greatly by industry. For example, hospitals and doctor’s offices have a much higher survival rate than restaurants or retail stores.
2. Years in business. As businesses mature, they get better at what they do. They increase their market share, build a loyal customer base and gain a reputation in the market. Survival rates in businesses increase exponentially with time; a business with several years of experience signifies a lower default risk.
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