Invoice Bazaar Blog

My working capital loan got rejected due to high leverage. What does it mean?

By Invoice Bazaar | January 12, 2022

If your business venture has high leverage, it means your firm’s debt-to-equity ratio is excessive or abnormal, and its operations are primarily financed by debt. A high leverage ratio is one of the most common reasons for loan applications getting rejected because high leverage indicates that the capacity of your business to repay debts is low. Banks and financial institutions avoid giving loans to those whose debt liabilities are too high against their possible income and assets because any further debt can put the scope for loan recovery at stake. Business enterprises that do not have a sound working capital management strategy may often become overleveraged.

One of the signs of being overleveraged or having high leverage is the skipping of interest payments or repayments of principal when due. Highly leveraged businesses may easily fall into a debt trap because they may be unable to continue with their business operations without further borrowings. Furthermore, the more they borrow, the less working capital remains in their hand after repayment of loan installments and interest amounts. Hence, overleveraging or high leverage can also be one of the earliest signals of impending bankruptcy. That is why it is difficult to get a working capital loan or business loan when you are overleveraged. Poor debt management can make a business overleveraged. And it signifies much beyond the rejection of loans. 

When a business venture has high leverage to be denied a working capital loan, it can also not gain new investors as word gets around. Besides the limitations on further borrowings, your firm also runs the risk of losing assets and financers taking possession of land and equipment vital for continuing with the business operations. Consolidation of loans is one way of lessening the burdens of overleveraging, attracting new investors to raise equity, and lowering the debt-to-equity ratio. Furthermore, selling off equity or merging with a bigger company are ways of coming out of an overleveraged and debt-stressed situation. Sometimes, it may be better to let go of part ownership if a business has good prospects than to go bankrupt.