The first stop for a business owner to secure additional funding is typically their bank, or their CPA who directs them to their bank for a business loan. Some entrepreneurs feel they have a relationship with the banker; and since the banks know “everything” about their business financials, it only makes sense that the business would qualify for a bank loan.
Unfortunately it’s not that simple. Like any other large corporation, banks are not always so easy to deal with. They offer limited capital flexibility, take a long time to provide answers and require a lot of information to do so. So why are bank loans so hard to come by? Here are the top 3 reasons it’s so challenging to get a bank loan in these days.
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1. Banks offer limited flexibility
Banks are typically large organizations, and large organizations need specific guidelines and rules to make sure they are successful. If you don’t fit in their “commercial loan box”, then there is zero chance for you to borrow money. A banker will help compile the loan documents and due diligence paper work to be submitted to a credit committee.
Regardless of the relationship you have with your banker, you will be judged by the underwriting packet you supply to the bank including resumes, business plans, cash flow projections, your balance sheet and past financials. In January 2015 Federalreserve.gov reported that “Nonprice terms generally remained about unchanged, except for a modest net fraction of banks which indicated having eased loan covenants”.
Banks will be looking closely at a few specific ratios including Debt Ratio (Total Debt/Total Assets), Debt Service Coverage Ratio (Operating Income/Debt Service), and Loan-to-Value Ratio (New Loan Amount/Collateral). A series of rather rigid checks and balances are implemented to limit a bank’s risk exposure to business loans. This requires a very strict underwriting process including a deep-dive due diligence process that can take weeks to complete.
An alternative lender can typically fund a business within 2-5 business days with limited paperwork.
2. Who has time for the mile long checklist?
Bank loan applications require a certain level of sophistication and a good amount of time. Bank applications can be 5-8 pages long and request anywhere from 6-12 separate documents from financials to legal papers. SBA loans, while marketed as an easy to use and readily available financing option require these 10 documents just to start the business loan process.
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Now we may be our own worst enemy here, but compared to the light paperwork a factor or alternative lender might require it may be worth the extra few bucks to take the easy way out. However, with Prime rates as low as 3.25%, that’s for you to decide.
Scalability of modern day businesses can’t be supported by typical bank loans
Some businesses models simply aren’t a good fit for bank loans. Now this isn’t to say that your business isn’t any good. It’s the banks haven’t changed their financing strategies and loan offerings to keep up with the new economy and modern day businesses. They are governed by strict rules and regulations and are very careful of getting into new creative areas of financing.
Some businesses like technology, data and ecommerce can scale so quickly that a bank offering simply can’t keep up. This makes it necessary to seek other forms of financing like friends and family, investors or alternative lenders.
Over the next few years we will see some major changes from banks as they realize they need to get out there and compete against alternative lenders, which will soon be known as the standard lenders. Alternative lenders are getting smarter and building technologies that will allow them to better measure risk and price their offerings accordingly allowing them to compete with bank rates.
So if you are having trouble finding a bank loan for your business, don’t worry. It’s not you, it’s them, and your banker will be knocking on your door in 12-24 months when they realize they missed out on a tremendous opportunity.