Bankers and other traditional lenders often turn to what they call the “Five Cs” when they’re evaluating a potential small business loan customer. The “Cs” answer many of the questions a banker might have about a borrower and are pretty easy to remember. While they harken back to a time before lenders could leverage technology to make decisions about you and your business, I think they are still a good place to start an internal assessment of your ability to secure a small business loan.
Most lenders recognize there are relatively few “perfect” borrowers. Nevertheless, character is an important “C.” This is why many lenders dive into your history as a business owner:-
- how long have you been around?
- have you been successful?
- what does your management experience look like?
- what is your reputation within your industry?
- and what is your reputation within the community?
Granted, this first “C” can be very subjective, but there are ways for a lender to get a glimpse into your character today that weren’t available a few short years ago.
For example, your reputation with your customers is an open book if you have an online presence. And, some lenders consider social media data and other online information to help them answer questions about this “C” as well as get insight to determine if you have a healthy business.
It’s on my list at number two, but many lenders use this metric as a primary go-no-go decision maker. They may also consider your personal credit score as part of the “Character” equation. Most lenders have a credit score threshold below which they can’t offer you a loan, so if you have a weak credit score your first objective should be to make improvements.
As a general guideline, a personal credit score below 680 will make it difficult to get a loan at the bank. And, a score below 650 will likely rule out an SBA loan, but many online lenders will work with borrowers with a lower score, provided other business metrics are in place demonstrating a healthy business. Nevertheless, the need to maintain a strong personal credit score will likely never go away for most small business owners, so it’s vitally important to have this “C” under control.
This is why a lender asks about revenues and cash flow. They want to determine if you will be able to make the periodic payment required to keep the loan current. No lender is interested in approving a loan to a borrower that won’t be able to make timely payments. This is one reason why it’s often difficult to offer a loan to businesses that don’t have a year or two under their belt—it makes it hard to evaluate this “C.”
Many online lenders will review your business checking account to ensure there’s enough cash flow to make the regular payments. Because they often make weekly or daily direct withdrawals from your account to make the loan payments, they want to make sure you have the type of cash flow (or capacity) that will accommodate that.
Most traditional lenders want to see that you’ve invested some of your own capital into the venture. In other words, they want to verify that you have some skin in the game. When a lender sees that you have invested some of your own money into the business, he or she will feel you’re less likely to walk away if things get tough.
Lenders also want to know that you have the financial wherewithal to continue making loan payments if something goes wrong. Having cash on hand to meet your day-to-day needs, and maybe even a little set aside for a rainy day, tells the lender that the business loan your looking for isn’t a last-ditch effort to keep your head above water for the next few months while your business falters.
Traditional lenders use assets like real estate or equipment as collateral, though anything of value that is relatively liquid may be accepted. Collateral reduces the risk to a lender by providing something of value in the event you default on your loan.
Some lenders don’t secure a small business loan with specific collateral, but rather place a lien on all your general business assets until the loan is repaid. With that in mind, while many of the new breed of small business lenders look at collateral differently than some traditional lenders, you will likely be asked about either collateral or your business assets when you apply for a loan.
I like the Five Cs as a way to evaluate whether or not a borrower is ready to see a loan officer. It’s a lot like knowing some of the key answers to a test before the teacher says, “Begin.” However, the “Cs” are really trying to determine the following three things:
- Can this borrower repay a loan?
- Will this borrower repay a loan?
- Do they have a contingency plan should something unexpected happen?
If you can demonstrate to a loan officer that the answer is “Yes” to these three questions, you will dramatically improve the odds of getting a loan approval.
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