Identifying the qualifications, exceptions , alterations, and finality of the lenders rejection  ON SBA LOANS helps the borrower to determine why the lender said no. The following list includes some of the most common reasons for rejecting a loan request and some logical responses for the borrowers.

Objection 1: The business is under capitalized

SBA Lenders want the borrower to have either contributed or earned a substantive portion of the net worth of the business. In comparing the total debt to the total equity, there should be some measurable part of the company’s financing provided from a source other than the lender.

Response : The borrower can take a number of measures to increase equity in the business

• The borrower can inject more money into the company from such sources as savings, a second mortgage on an owner’s home, liquidated investments, and the cash surrender value of a life insurance policy.
• The borrower can convert any subordinated debt or notes payable to the company equity. Although this act may have consequences of and when the holders want to withdraw the money, it may be necessary to convince the lender of the borrower’s commitment to the success of the business.
• The borrower can reduce any other liabilities of the company to a reasonable extent, at a discount if possible. Lowering the debt leverage can permit lenders to have a stronger position, without other liabilities distracting from their ability to be repaid.
• If the borrower does not have additional capital to contribute, maybe relatives,friends, employees, or suppliers would be willing to invest in the business. This additional capital could be structured to ensure their priority in redemption as soon as the business accumulated additional capital to satisfy the requirements of the lender.

Objection 2: The business has not earned money yet

SBA Lenders expect that the borrower can support the business strategy with a track record of business success. If the company has perpetually lost money, most lenders may reason that additional financing will compound those losses and the borrower will be unable to repay the borrowed funds.

Response : The borrower’s explanation of the financial history of the business (suggested earlier in the book) was not sufficient or was not reasonable. If the business has failed to make a profit, it is important to demonstrate why and to explain how the borrower will correct the problem.

Sometimes the borrower’s strategy to earn profits is as simple as acquiring more efficient assets to achieve profitability. Lenders are less comfortable about financing this strategy if the borrower can prove that increases in productivity will indeed provide profits.

Sometimes, however, the strategy may be as vague as projecting additional expenditures on advertising and marketing. Lenders are less comfortable about financing this strategy since there are so many undefined and poorly understood variables that can cause failure.

The borrower should provide candid and detailed documentation explaining the periods in which a profit was not earned. In comparing those loss periods to periods in which the business did earn profits, the borrower can explain how the operations may have been different. Then the borrower should explain how the loan proceeds will be used to position the enterprise in a manner that can return or deliver profits to the business.

Objection 3: The proposed loan is too much money

Lenders  try to minimize loan requests by either reducing the marginal funds or trying to minimize loan requests by either reducing the marginal funds or trying to force the borrower to spend less in a particular part of the proposal. Their intent is to control their exposure and perhaps get the loan balance down as a percentage of the collateral.

Response : Only the borrower can decide of the business strategy can be achieved with a lower amount of funding. And, typically, only the borrower will know how much extra financial padding, incorporated into the request, can be lowered and not affect the business.

The borrower’s response has to be on how much money is actually needed and how an expenditure can be reduced without having a negative impact on the business plans. Alternatively, offering to provide additional collateral may cause the lender to reconsider the restriction, since the borrower has reduced the lender’s perceived risk in the transaction.

Objection 4 : The business strategy is not sound

SBA Loan officers will test the borrower’s ideas against their collective experience (or inexperience) to evaluate whether the business has a reasonable chance of succeeding. If lenders have strong reservations about the borrower’s prospects, they will not provide financing.

Response : Lenders are not always correct and they are almost always conservative. Maybe the borrower did not explain the business concept sufficiently to the lender, or maybe the loan officer has an incorrect or incomplete understanding of exactly what the borrower plans to accomplish.

The borrower should review the business strategy carefully, making sure that it fully describes each detail of the concept. These ideas can be supported with the articles, surveys, and marketing studies, and demographics that influenced, inspired, or convinced the borrower to undertake this strategy.

Objection 5 : The business is too risky

Lenders exclude some industries from their lending market because the real or perceived risks inherent in those businesses are beyond the acceptable parameters of the lender. These exclusions may apply only to the local lender, or they may be fairly common among most lenders, depending on the industry within which the borrower operates.

Response: Perhaps the borrower has not effectively communicated how some of the risks can be counterbalanced. Depending on the locale and nature of the industry, the lender that may not want to finance the business may be the only lender that can.

Therefore, the borrower has to convince the lender that the risks can be eliminated or limited. For example, by accepting tighter terms or providing sufficient collateral, the borrower can structure the transaction to protect the lender from exposure to costly servicing or potential loan losses.

Objection 6 : There is not enough collateral

This objection is probably the one most often used by lenders to turn down a loan. The lender wants a minimum of 1:1 collateral coverage, based on a discounted valuation of that collateral. Usually lenders will use their leverage to encumber virtually every asset the borrower has, even if those additional assets contribute little or no value as collateral to secure the loan.

The quantity and sufficiency of the collateral can overcome many objections, because lenders are usually too glad to rent the borrower its own money, even when that money may be tied up in other assets that can be encumbered for liquidation should the loan not be repaid.

Response : The borrower’s response should be based on an honest recognition of the true value of the collateral. How much would it be worth in liquidation ? Lenders are inclined to sell off repossessed assets grossly under market, seeking merely to recover their loan balance rather than getting the full value of assets.

The borrower must learn about the market for selling assets similar to those offered as collateral. For example, a ten-year-old lathe that cost $5,000 has a discounted value for the lender. The borrower should pay for an appraisal from a used equipment dealer or equipment auctioneer. The dealer can quickly assess what the equipment would bring in a timely sale or in an auction. This information is germane to determining the leverage the lender will give the borrower on those assets.

Real estate assets also have to be valued, based on appraisals. The lender will typically advance a standard amount of the market value, thereby providing a margin for the lender to cover the time and associated cost of selling the property.

If the lender has not valued, the collateral adequately, the borrower can provide additional information to prove the value. The borrower can challenge the lender’s assessments only when a different value can be documented. When asked to review their reasoning, lenders can at least recognize a compromise value based on the evidence produced by the borrower.

If the assets are insufficient, the borrowers should offer to provide more collateral. Sometimes there are creative solutions to obtaining collateral value from assets that cannot be pledged. The borrower should review personal and business financial statements carefully, searching for a way to assign values to the lender.

In the absence of such collateral, the borrower can seek assistance from relatives, friends, associates, or investors who might be willing to hypothecate personal assets to the lender in order to secure the loan. In effect, these third parties would be providing a limited guaranty for the loan, only to the extent of their ownership in the assets would agree to use as collateral for the loan.

Objection 7 : The financial projections are unreliable

Lenders will pay particular attention to the financial projections of the proposal to determine exactly how the borrower intends to repay the loan. Based on contributing factors, the lender does not always agree with the conclusions about revenue production or the cost of operations. If the lender does not accept the projections, the borrower’s ability to service the debt becomes questionable.

Response : The borrower should examine the projections carefully and ensure that the expectations have been adequately communicated. Reviewing the data or historical figures on which these projections have been based, the borrower should ensure that this evidence is documented in the footnotes of the pro forma.

The borrower may need to make modifications to correct an error discovered by the lender or to revise the calculations. When comparing the new numbers against the debt service to pay back the loan, the borrower can determine if the deal is still feasible.

When confident with the numbers, the borrower should present them again with a line-by-line discussion (as necessary) to convince the lender of the soundness of these expectations. Determining the basis of the lender’s or doubts, the borrower can attempt to validate those specific entries thoroughly.

Responding to any of these objections does not guarantee that the lender will change the decision, but it is the logical step to take after the loan has initially been rejected. Since considerable effort has been invested in educating this lender about the company, the borrower should try to address these concerns before completely starting over with a new proposal to a new lender.

P.S. As always, please take a minute to leave a comment on my blog. I want it to be a conversation rather than a rant from my soapbox.
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