When business owners seek funding, understanding how lenders make their decisions can provide clarity on how to increase the chances of approval. Lenders are cautious about who they lend to, as they need to ensure they’re likely to get their money back, along with the agreed interest. Here’s a breakdown of the primary factors lenders consider before approving or rejecting a business loan application.
1. Creditworthiness and Credit Checks
One of the first steps a lender takes is assessing the creditworthiness of a business. This often includes reviewing the business’s credit history as well as the personal credit records of the business owners or directors.
Business Credit History
Lenders check the business’s history of handling credit. If your business has consistently met payment deadlines, this reflects positively on its reliability. On the other hand, missed payments, defaults, or County Court Judgments (CCJs) may raise concerns. Businesses with poor credit histories may find it more challenging to secure financing or might face higher interest rates.
Personal Credit Checks
Many lenders will also assess the personal credit records of the business owners. If you have a strong personal credit history, it can work in your favour. However, personal financial issues such as defaults or adverse entries can reflect poorly on your ability to manage business finances and may reduce your chances of approval.
Hard vs. Soft Credit Checks
If you’re only exploring options, it’s important to ask lenders if they can perform a “soft” credit check, which doesn’t affect your credit score. Too many “hard” checks can appear on your credit report and potentially reduce your chances of securing a loan in the future.
2. Financial Performance: Profitability and Cash Flow
Lenders will carefully analyse your business’s financial health, focusing on profitability and cash flow. This helps them assess whether your business generates enough income to comfortably cover loan repayments.
Profit and Loss Statements
Lenders typically require one to three years of financial accounts to review. This allows them to evaluate the business’s revenue, expenses, and profit margins over time. Positive, stable profitability suggests the business is well-positioned to manage debt.
Cash Flow Projections
Beyond historical performance, lenders look at future cash flow projections. They want to see evidence that the business will continue to generate sufficient cash to meet its financial obligations, including the loan repayments. Strong financial forecasting, supported by realistic assumptions, can enhance your application.
3. Existing Debt and Financial Commitments
If your business already has significant debt, lenders may view additional lending as too risky. This is because existing financial obligations can affect the business’s ability to take on more debt responsibly. A high level of debt might either lead to a rejection or, at the very least, a higher interest rate to offset the increased risk.
Lenders typically look at the debt-to-income ratio, which compares total debt to the business’s income. A lower ratio indicates that the business has more income relative to its debt, which is generally preferable from a lender’s perspective.
4. Security and Collateral
Collateral is an important factor in a lender’s decision. Many lenders require businesses to pledge assets, known as collateral, to secure the loan. If the business defaults on the loan, the lender has the right to seize the collateral to recoup its losses.
Common Forms of Collateral
Lenders often accept real estate, vehicles, equipment, or accounts receivable as collateral. These tangible assets provide a level of security for the lender. In some cases, personal guarantees may also be required, which puts personal assets of the business owner or directors at risk if the business defaults.
Enterprise Finance Guarantee (EFG) Scheme
For businesses with strong potential but limited collateral, the UK government offers support through the Enterprise Finance Guarantee (EFG) scheme. This programme provides a government-backed guarantee for a portion of the loan, reducing the lender’s risk. However, borrowers must pay a fee to access this guarantee, which adds to the cost of the loan.
5. Purpose of the Loan and Business Plan
Lenders will want to understand how you intend to use the loan. This helps them gauge the risk and viability of the loan in relation to your business goals.
Defined Purpose
Whether the loan is for expansion, equipment purchase, or cash flow support, lenders appreciate clear and specific plans for how the funds will be used. Businesses that present a well-defined purpose backed by thorough planning often have an advantage when applying for loans.
Sector Risk and Market Conditions
Different sectors carry varying levels of risk, and lenders may have different appetites for each. For example, a lender may be more cautious about lending to industries facing economic downturns or high levels of competition. It’s worth researching if your chosen lender has any sector-specific policies before applying, as some banks might be more supportive of certain industries.
6. Personal Investment and Commitment
Lenders often view personal investment by the business owners as a positive indicator. When business owners have invested their own capital, it signals confidence and commitment to the success of the business.
Personal investment shows that the owner has “skin in the game,” making them less likely to walk away if challenges arise. In some cases, lenders may even require that a certain percentage of the funding be sourced from the business owners themselves.
7. Economic and External Factors
Broader economic conditions can also influence a lender’s decision. During economic downturns, lenders may become more conservative with lending, raising their requirements or tightening loan terms.
Industry-Specific Risks
Lenders also consider factors affecting specific industries. For example, economic or regulatory changes impacting a particular sector can make lenders hesitant to provide funding. Similarly, if a business operates in a highly competitive market, lenders may perceive this as an added risk.
8. Business Registration and Documentation
Lenders will review publicly available information about the business, such as records from Companies House. This includes details about directors, financial filings, and any previous legal issues involving the business. Ensuring all your documentation is up-to-date and accurate before applying can strengthen your application.
Accurate Records
Keeping financial statements, tax records, and other important documents in order demonstrates to lenders that your business operates with transparency and professionalism. This helps build trust and can be a deciding factor when lenders assess borderline applications.
Are You Likely to Be Accepted or Declined for a Loan?
Securing a loan depends on meeting a range of criteria, from demonstrating strong cash flow and profitability to offering suitable collateral and a clear plan for using the funds. While certain factors, like economic conditions or industry-specific risks, may be beyond your control, preparing thoroughly in areas you can influence will strengthen your application. By understanding the requirements and presenting a well-organised, transparent proposal, you can improve your chances of being accepted for the financing your business needs.