Why Do Banks Say No to Business Startup Loans?

And What to Say and Do Next

Saying No to Business Loans
••• Why a Bank Says NO to a Business Loan. mattjeacock/Getty Images

Why Do Banks Say No to Startup Loans?

It is very difficult for a new business to get a loan from a commercial bank or lender for business startup. New businesses are in fact the most risky loans of any that a bank or lender might encounter. So understandably they are nervous about startup loans. 

Why Business Startups are Risky 

To understand why new business startups are risky for business lenders, we need to take a look at the  four C's of Credit (collateral, capital, capacity, character). 

Lenders expects the borrower to have 

  • Capital - Business assets that can be used to create products or services and which can be turned into cash to make payments on business loans. A new business, especially a service business, has few business assets. 
  • Collateral - Cash to contribute to the business. A new business owner has little collateral unless he or she can use personal assets or has a co-signer with assets to pledge. 
  • Capacity - A track record to show that the business has the capacity to generate enough money to pay back the loan.
  • Character. This is primarily a good credit rating. if you have a good credit rating, though, it doesn't mean you can get a business loan, but a poor rating will probably get you turned away quickly. 

Banks are pretty creative when it comes to reasons for saying no to a startup loan. These are typical responses by banks to a young couple who were seeking a loan to start a professional practice. 

Typical Bank Responses to Startup Loan Requests - And Your Response

Just Because.
Banks will often say simply, "We don't give loans to startups."

Your response: Move on to other banks. Sometimes it takes a while to find the right one. 

100% Collateral.
One bank said it would give an $80,000 loan at 8% interest if the borrowers would have their co-signer put $80,000 in the bank (at 5% interest). When the borrower asked them why he shouldn't just take the $80,000 to start his business, they responded, "This way you get business credit."

Your response: You can't get business credit unless you have a business. Move on, or consider other alternatives.

Limiting Loan Amounts. Another bank would only give them $50,000, saying that was the limit for "SBA express loans for startups."  

Your response: Before you talk to banks, talk to the SBA. Find out their criteria. Some banks are more willing to deal with the extra paperwork and hassle of SBA loans. You can go to the SBA and get tentative approval, to cut off the bank objections. 

Equity from Owner. A bank I heard of said it wanted a "required equity injection" (that is, cash from the owner. If the bank loans $80,000 and requires $30,000 from the owner, the bank is really loaning only $50,000. 

Your response: Be prepared by suggesting a co-signer (someone who will pledge to help you with the equity requirements. 

Business Loans and Your Business Plan

One of the best ways to get a startup business loan is to craft your business plan carefully to answer all the questions a lender might ask and the objections that might be raised.  

  • Show you you plan to contribute capital to the business. What are you contributing yourself? What do you already have (that's paid for)?
  • Show where your collateral will come from, and the credit records of you and any co-signer.
  • Show the management expertise you, your advisors, and executives have to guide the business quickly to profitability. 
  • Include spreadsheets to show when your business will have a positive cash flow (not just profit) and that you are spending less than you bring in. 

Personal Credit and Startup Loans

Because new businesses don't have credit of their own, the bank has to look at the credit of the people who own the business. Banks often deny startup loan requests because the personal credit of the borrower has problems. For example:

  • The problem may be as little as one negative rating on your credit report, but that may be all it takes for a bank to say no.
  • Low credit ratings also effect ability to obtain startup funding. These days, any score under 800 is suspect, so you will need to know your credit rating and work to raise it.

Ways to Get a Loan Without Bank Financing

The best thing you can do if you are denied bank funding is to go to other sources of funding or alternative lenders

Read more about the SBA 7(a) loan program on the SBA website.