As a business owner, you want to be in a banker’s good graces. If you ever need capital to grow and explore different opportunities and you don’t have cash in the bank, you need a loan. While every bank has its own unique criteria to be approved for a traditional loan, many base their credit decisions off of the “Five C’s of Credit:”
- Character
- Cash Flow
- Collateral
- Capitalization, and
- Conditions
Before reading the rest of my article, be sure to register below for a special live webinar event where I will be discussing different sources of capital for your small business.
Character — Your willingness to pay back your loan
Bankers want to lend their money to those who have good credentials and references.The character question consists of the way you treat your employees and customers, the way you take responsibility, and also your timeliness in fulfilling your obligations. This not only covers your life as a business owner, but also your personal one. Both aspects gives the lender an idea about how likely you are to handle leadership as an owner, especially in a business crisis. It’s a banker’s responsibility to be pessimistic about giving a loan.
As small business owners, our personal stamp on everything that affects our companies is essential. Since the bank will probably not know you on a personal level, your credit score tells the lender how you will pay your business loan. Most of the time, banks do not even differentiate between us and our businesses. A poor personal credit score is enough insight for a lender to outright decline a loan. There is no difference between handling personal obligations and business obligations.
Cash Flow— Your capacity to pay back your loan
This would cover your business’ borrowing history and track record of repayment to the amount of debt your business can handle. The lender needs to know if you are able to honor the obligation to repay debt. Financial benchmarks, such as debt and liquidity ratios, are evaluated. Be sure to become familiar with the expected pattern in your industry. Some industries can take a higher debt load. Others may operate with less liquidity.
Collateral — How lenders get paid if the business fails
While cash flow will usually be the primary source of a loan repayment, bankers look at what they refer to as the secondary source of repayment. Collateral represents assets that your business pledges to use as an alternate repayment source. This could be real estate or even office and manufacturing equipment. Bankers typically discount an asset and lend on that basis. So, for every $1 of collateral, the bank will lend anywhere from 70% to 85% of the value depending on whether it is fair market value or liquidation value.This would be a major issue for a service business since they have fewer hard assets to pledge.
Until your business is well established, you’re nearly always going to pledge collateral. If it doesn’t come from your business, the bank will look to your personal assets. Now, this clearly has some risks. If you don’t want to be in a situation where you could possibly lose your house because a business loan has turned for the worst, then you need to think about this collateral question. You need to consider all the possibilities before jumping into this type of commitment.
Capitalization — How much money have you put into the business?
Banks often want to see that you have a financial commitment and that you have put yourself at risk with your business. Both your business’ financial statements and your personal credit are keys to the capital question. For example, if your business ends up operating with a negative net worth, are you prepared to add more of your own money into it? It’s a matter of how far your personal savings can support you and the business as its growing.
Conditions — SWOT: The Strengths, Weaknesses, Opportunities, and Threats that affect your business.
If your business is sensitive to economic downturns, the bank wants reassurance that you’re managing productivity and expenses. They want to make sure that your business is keeping up with the trends in your industry and if there is anything that could negatively impact the growth of your business.
Remember, lenders don’t give equal weight to each of these credentials. If there is one weak area, this could possibly offset all the other strengths that you have. For example, if your industry is sensitive to economic swings, your company may have difficulty getting a loan during an economic downturn regardless of all other strong factors. Also, if you’re not perceived as a person of character and integrity, there’s little likelihood you’ll receive a loan, no matter how good your financial statements may be. Bankers are cautious, and want to make sure that they are lending their money to the right people.
Banks evaluate your company as a total package, which is often more than the sum of the 5 C’s. However, the biggest element will always be you.
Steve Koval
Don’t miss our special live webinar event, “How to Find Capital,” this Monday, April 13th at 4 p.m. EST. Learn about different sources of cash you can use to help grow and expand your business! Register HERE.
