Every business owner’s story is unique, yet many will reach a point where they ask the same question – how can I help my business grow? Sometimes the answer to that question is a loan, and knowing ahead of time what lenders will look for can help you simplify the process and secure financing faster.
A business loan or line of credit could enable you to take on larger projects and manage business growth, while maintaining positive cash flow. Bankers want to know your plans for financing, followed by what your aspirations are for growing your business. Bankers also consider the “Five C’s,” which are character, capital, capacity, collateral and conditions.
Although businesses don’t have credit scores, your company’s credit history and reputation help determine its creditworthiness. Banks evaluate your company’s debt repayment history, your business references, the quality of your product or service, and whether you have a good reputation. Furthermore, as a business owner, your personal handling of credit is also an excellent gauge of your likeliness to repay a business loan.
Your company’s capital is measured as a percentage of your total investment cost. Lenders want to see that you have “skin in the game,” so in addition to your business assets and earnings, they want to see your personal investment as well. The more capital you personally invest, the greater your commitment to the success of your business. When your own money is involved, it serves as an incentive to not default on a loan.
Most financial institutions want to ensure your company’s cash flow allows for repayment of the loan according to its terms. Additional factors include the number and amount of any current outstanding debts compared to your expected monthly income. As a good rule of thumb, keep a simple calculation in mind: for every $1 of debt, ideally your business would have at least $1.25 of cash flow.
Collateral is the asset used to secure your business loan or line of credit, such as real estate, equipment, accounts receivable, vehicles, inventory or other business assets. Your bank may also accept a second or third lien on a primary residence as collateral. Most banks lend only up to a certain percentage of the asset’s appraised value, and may also factor in the asset’s ease of liquidation.
In addition to collateral, some banks would like to see a personal guarantee from their borrowers. This practice puts the financial institution in a safer position and encourages the bank and business owner to continuously work together to ensure the success of the business.
This final variable pertains to the economy. Factors outside of your control, such as an economic downturn – in general or specifically within your industry – or, perhaps the bank already having many loans within the same industry, may result in the bank passing on your loan due to higher risk.
Although every financial institution has its own parameters for analyzing a company’s creditworthiness, the five C’s are common evaluation methods. Overall, the bank and the business owner should form a strong partnership in which each is successful. This ensures that your business receives the financing it needs to grow, and the bank has measures in place to protect itself.