The 5 C’s of Small Business Lending

Starting a small business can be a daunting a task.  Most small business owners need a small business loan to get started.  Traditionally most owners went to banks, but it’s reported that 59 percent of small business owners look at the bank, but only 27 percent end up finding financing there.  Some sources say the percentage of owners who receive financing at a local bank is even smaller, more like 10 percent.  Banks are becoming more frugal in lending to small business owners, taking their risks on larger companies with history of sales.

Heading into the bank with knowledge of what you are going to be asked is the best way to be prepare yourself for obtaining a loan.  Think of it as a teacher going over the answers to a test, before you are given the test.  Here are the five C’s, what your banker wants to know about you and your business:

Character: This is an important part of how the bank will evaluate potential customers.  Although credit score is a major factor, character also plays into an application.  Banks want to see a good management team, and know that even though the applicant may not have perfect credit they still believe in them enough to supply you with financing.

Credit Score: Although different lenders are willing to work with owners with different credit scores, most lenders do have a threshold they won’t go below.  Lenders tend to describe your credit score as a measure of your willingness and commitment to meet your financial obligations.  Your credit score is critically important, so when you meet with a lender you should know your score and be ready to explain anything negative on your report.

Capacity: This is the monthly or annual revenues question. No lender is interested in giving a loan to someone who has no means to repay it. What’s more, even if you have great credit and are in an idea-stage or early-stage startup and have no revenues, it’s probably not the best time to be looking for financing.

Capital: This is the cash the banker expects you to have on hand before you are offered a loan. It’s important to remember that bankers are highly risk averse and want to make sure borrowers have a little bit of skin in the game. From their perspective, the thought is a little skin in the game will make it harder to walk away. It makes sense too, but we all know your blood, sweat, and tears are a pretty substantial investment too. Having some cash on hand for day-to-day cashflow and maybe a little set aside for a rainy day tells the lender the business loan you are looking for isn’t a last-ditch effort to keep your company alive for the next few months while your business continues to falter.

Collateral: Banks and other traditional lenders consider assets like real estate or capital equipment as collateral. Alternative lenders might consider your accounts receivable or monthly credit card receipts as collateral.

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