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5 C's of Small Business Lending
Published on Apr 23, 2012
What are the 5 C's of Small Business Lending? Learn more at 'Time to Start Up,' the small business blog by BizFilings.
Become familiar with the 5 C's of lending to help secure funding for your small business.
Credit refers to the money loaned to the business, and the business' ability to borrow more money. Lenders that are evaluating your business' creditworthiness will consider multiple factors. They will examine your credit history, amount of credit used, number of inquiries, past and present credit issues, outstanding balances and unsecured debts, among other things. By evaluating all these factors, a bank will get more insight into whether your business is a good candidate to receive a loan.
A bank or other lender will often ask a small business owner to pledge assets in order to be considered for the loan. The assets will function as collateral - the second C - for the lender, if you fail to fulfill your side of the deal by repaying the loan. Collateral commonly takes the form of business-owned real estate or equipment, or cash savings, but there are other types of collateral. For instance, a lender might accept a purchase order as collateral against a loan needed to fulfill the order. Depending on the type of collateral available to secure a loan, it might be wise to register your business as a limited liability company. By separating personal and business assets, this provides some protection to business owners in the event of a default.
While credit and collateral are well-known concepts to business owners, the third C, capacity, may not be as familiar a term. Essentially, capacity refers to your business' ability to repay a loan. Businesses that are just starting out will of course not have a track record when it comes to revenue, and, because their success will not be proven, banks will rely upon the strength of a business plan to determine capacity. Therefore, at the beginning of the loan process, it's essential to draft a detailed proposal regarding how much money is needed and how it will be spent to boost revenue and enable your business to repay the loan.
Banks and other prospective lenders will also assess your cash flow, which refers to the inflow of funds that enables a business to pay its bills and meet other financial obligations. Once again, new businesses may not have an established revenue stream to point to; however, lenders will examine the business plan in light of factors such as off balance sheet debts, personal debts of the owners, vendor payment schedules and accounts receivable/payable. Lenders typically look for a debt service coverage of about 1.25, which means the business has yearly revenues about 1.25 times greater than the amount of debt it must cover annually.
What could be the most important aspect of your business is your own character, showcased by your financial history. The bank will look at things such as your trustworthiness, whether you have a backup plan and how you will be able to respond to critiques and requests for additional information.
Although the 5 C's offer an easy-to-remember framework for maintaining creditworthiness, devising and executing a strategy that addresses each of the C's can be anything but easy. Small business owners might take advantage of resources to help in this endeavor; for example, by turning to the U.S. Small Business Administration affiliated non-profit organization SCORE. In addition to serving as a repository of general business advice, SCORE offers resources tailored to specific types of entrepreneurs, such as minorities, women, seniors and veterans.