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COVID-19 SIngapore: 8 Possible Reasons Why Your SME Business Loan May Be Rejected
As most business owners may know, trying to apply for a business loan as a small business is a difficult and cumbersome process. There's a seemingly simple reason for this - smaller businesses and startups are considered by banks and conventional lenders as some of the riskiest loans in comparison to bigger, more established corporations. In that regard, it's not difficult to understand the hesitation banks have when lending money to Small and Medium Enterprises (SMEs).
In any case, it's not impossible to get your loan approved, especially now that SME business financing in Singapore is a prominent priority for the government's efforts in fighting against the Covid-19 pandemic. But here are a few possible reasons why your SME business loan might be rejected.
- Too many returned cheques sighted in the bank statements
Most banks have a guideline that there should not be more than three returned cheques sighted within the latest 6 months’ bank statements.
Recurring returned cheques reflect negatively on the company’s repayment ability, cashflows, as well as the company’s integrity. Although sometimes it may be due to wrongly filled amount or spelling mistakes, returned cheques due to insufficient funds are a big “No-no” to the banks, as this will reduce a company's credit worthiness.
- Lack of clarity on the use of funds
This issue becomes even bigger depending on the amount the borrower is asking for. Hefty amounts of funds that range up to a million or more, usually require a bit more clarity in regards to exactly how a business owner will allocate those funds. Banks and financial institutions have a lot at stake in terms of lending that much money, and so they would like to see a thorough report on how the business loan applicant intends to distribute, track and manage the spending. Is it used to reinforce capital, or boost the production of your business capacity? Will it be used to cover short-term financial obligations or a combination of different expenses?
SME owners who do not have a clear and well-described idea on how they are going to use that money are diminishing their chances of getting the loan approved as some banks will have a credit call before the final approval, and will require a clear explanation on the usage of the loan.
- Company is newly incorporated or less than a year
Another common reason business loan applications are denied is because the company has just been formed recently. In fact, new company owners often apply for business loans even before their business has run for a year or more. This will not help to build lender confidence because having a track record is a major factor to trust. The financial institution's credit evaluation process bases its decisions on the financial statements of a borrower's company - including its accuracy, accounts and analysis of finances.
This is especially crucial as more than 70% of newly incorporated SMEs fail during their first three years of incorporation, thus this is why some banks’ internal guideline is to only provide business financing to companies that are incorporated for more than 3 years.
For newly incorporated companies, SMEs can approach OCBC for their Business First Loan, as the main assessment is based on directors’ Notice of Assessment (NOA) from Inland Revenue Authority of Singapore (IRAS) for the past two years, and the company only needs to be 6 months old to be able to apply. However, the loan amount is capped at S$100,000, which should be more than sufficient for new company’s cash flow.
Alternatively, SMEs that are less than 3 years old can approach DBS for Working Capital requirements as they are well known to onboard younger SMEs.
- A change in business structure
This is less common, but it's still a mistake on the business owner's end. Sometimes there's a change in business structure just days before the actual loan application. This is understandably suspicious in the eyes of lenders because it gives an impression that business management is sloppy at best. Another thing that lenders often want to see in a company is stability in structure, production process, partnering vendors and revenue records among other things. Banks need a frame of reference, one that entails your enterprise history from which lenders can get tangible information.
- Financial loss making for the latest financial year
It's a challenging time for virtually every business out there right now, and the Covid-19 pandemic has led to many SMEs requiring financial help. Unfortunately, this still means that businesses are expected to have some semblance of profitability on their end if they intend to apply for business loans. It's a common qualifying trait for business loans, even with the crisis at hand. Nobody wants to bet on a losing venture (so to speak). Therefore, businesses are expected to be profitable for the last financial year. The financial year in question could be ending December 2019 - before the virus made an impact - or 31st December 2019 in case accountants didn't prepare 2019's financial statements.
In the past, banks used to only provide financing to companies that record positive financial figures for the latest financial year’s assessment. But given the current Covid-19 situation, most banks have laxed this guideline and we have seen SMEs that actually have loans approved despite making a loss for the last financial year. Nonetheless, SMEs will still need to have positive net worth in their balance sheet as negative net worth balance will deem the companies as technically insolvent.
- Too many existing loans
This is a cause for concern in the situation whereby a business has already applied for too many business loans and the existing monthly debt repayment obligation of the organisation is too high. This could mean that it is more probable that the company might not be able to repay the business loan in question through normal business proceeds, which ultimately translates to new loans piling onto more debt on top of the company's current outstanding dues.
If SMEs have displayed prudent financial management in previous years, then there are some financial institutions that have introduced moratorium options to allow for 6 to 12 months deferment of principal repayment (which basically means the borrower only pays interest for the period opted). This is referring to the Enhanced Financing Schemes for Working Capital Loan or Temporary Bridging Loan Programme initiatives that help SMEs with cash flow issues.
- Bad Credit Bureau Record of Directors/ Shareholders
One of the more common reasons why loans are rejected is because of the director's bad credit scores. Bad personal credit scores include having a history of late payments, active bankruptcy, involuntary closure of personal credit facilities or other issues. In this case, credit scores give lenders an indication of the SME owner's ability to perform and pay his or her dues.
Not only do banks assess the creditworthiness of the directors who will act as personal guarantors to the business loan, they will also assess the total utilization of their credit limit.
For example, if the company directors are constantly utilizing their credit limit of more than 70% (most bank assessment ratio) without doing full payment on a monthly basis, or directors have been drawing cash advance from their credit cards, this will negatively affect their business loan application. This reflects poor cash management of the directors and banks might assess the application as a case of the company taking the loan to pay off the directors’ personal debt.
- Pending litigation against the company
Litigation can be of many kinds, which includes motor vehicle accidents (common among construction companies), contract dispute, fraud / misrepresentation, etc.
For motor vehicle accident claims, such cases will usually be covered by their own motor insurance. As long as they have a letter to show that the insurance company will bear the costs, it will usually not affect the business loan application.
However, if there’s a writ of summon filed against the company, and depending on the claim amount, this will negatively affect the business loan application as for such cases, banks will not want the company to take a business loan that is meant for working capital requirements, and end up using the funds to finance the lawsuit.
For smaller claim amounts, if a company can show they have sufficient funds in their bank accounts to pay for the lawsuit without affecting the cash flow of the company, banks will usually still approve the business loan application on a case by case basis.
Read also: COVID-19: The Rise of Alternative Lending
Read also: Best SME Business Loan Comparison in Singapore 2020