Rising interest rates and uncertain economic conditions have intensified the slowdown in financing-related activities among small business, according to the NerdWallet Small-Business Financing index. This is supported by a recently released survey from the Federal Reserve that demonstrates how the pandemic altered the financial picture for small business. About 85% experienced financial difficulties in 2021, up nearly 20 percentage points from 2019.

While inflation is the highest in decades, and workers are demanding higher wages, even in normal times it can be tough for a smaller business to get loans from traditional banks because they lack the assets or credit histories of larger companies. And in many cases, they lack an understanding of the issues that drive the lending decisions made by banks and other lenders.

Delayed Documentation
We are working with multiple clients that are behind on taxes for multiple years. In several cases, financial statements lag as well. And yet, despite this lack of financial data, these companies continue to seek operating loans to continue operations. The disparity explains the relatively low success rate for companies seeking debt financing.

Only about 30% of business that applied for financing last year received the amount they requested, down from about half in 2019. And the President of the National Small Business Association, an advocacy group, said the current loan environment could make it tougher on smaller business trying to recover from the pandemic. Their balance sheets, which banks use to assess loan applications, were weakened during the pandemic, even if their future looks bright.

In February 2021, big banks approved 14.7% of loan requests, down from 28.3% in February 2020. And small banks approved 20.5% of loan requests, down from 50.3% in the same month in 2020. That’s according to the online lender Biz2Credit, based on data from more than 1,000 small business owners who applied for funding on the company’s platform.

Alternative Approaches
The larger banks’ stinginess has led business owners to consider other options such as community banks, asset-based lenders (ABLs) and online lenders. Owners were more likely to apply for an online loan last year than in 2020, while applicants were less likely to seek financing from a small bank, the Fed survey shows.

There are tradeoffs however: Alternative loans can be easier to get but are likely to come with higher interest rates or steep penalties. Typically, traditional banks’ small business loans carry interest rates up to 7%, or greater while online loan rates vary widely but can easily be 10% and higher.

We're in that part of the cycle where credit availability is going to get tighter. The fact that a lot of small-business lending is short-term in nature and often involves floating interest rates could make rising interest rates even more challenging for small businesses that need capital.
 
It's going to cost more to get credit. Underwriting standards are going to get tougher because you're going to actually start seeing delinquencies and defaults, and the banks don't respond to that by going, “we need to be looser with our money.” They respond to that with tightening up their underwriting requirements.
 
Finding the Right Fit
A tougher lending environment means business loans will likely come with higher price tags in the coming months, but experienced business advisors know there are things entrepreneurs can do right now to get lower interest rates.
For companies without an existing relationship with a lender, now may be a good time to make one. It has been suggested that connecting with a local banker who has some autonomy in the underwriting process can make all the difference during a tight credit market. They know what their underwriters are looking for, and they will do the coaching with the business owner to make sure that the balance sheet looks the way it needs to look. A local banker might also look at credit reports and payment histories ahead of time to make sure there are no red flags on your application.
 
To get approval on a business loan, owners need to be sure that company financial statements and tax returns are correct, complete and current, as well as being able to explain to lenders what each line item means on the financial statements and what story that tells. Management also should be able to explain how the information included on tax returns ties to the information on its financial statements.
 
And if a company lacks the contacts or expertise, they should not be afraid to ask for help before pursuing a loan. While occasionally a “yes” turns into a “no”, rarely does the reverse hold true.