If any of these questions are on your mind, read on and we will help you answer them:
- Do you think you need a line of credit or a term loan?
- Do you understand the differences between an LOC and a term loan?
- Is your business ready to borrow?
- Will you qualify for a loan?
- Will the bank be willing to lend to you?
- What loan terms and conditions are appropriate?
- Will the business be able to meet the standards required by the lender?
- Which bank should my business use?
- Which banks like to lend in my industry, and which don’t?
- What information will a bank want from our business to consider a loan?
The fundamental considerations which banks use to qualify borrowers are frequently described as The Five “C”’s of Credit.
Understand that every bank is different, and you will find slightly different versions of this on bank websites or in your discussions with specific bankers. Even individual loan officers within the same bank may have varying focus on which of these considerations is a higher priority.
- Conditions:
The state of the economy, trends in your industry and any regulatory constraints on your business. This also includes the condition of your business: New or established (Many banks will not lend to a business less than two years old for example). Is your business growing, stagnant or are profits declining?
- Capacity:
Does the borrower have adequate cash flow to make the payments, plus a cushion?
- Capital:
How much Equity has the borrower invested into the business and accumulated through retained earnings? If you take out every penny earned, and spend it personally, you have little or no equity and borrowing will be difficult. If you have strong equity, borrowing is easier.
- Collateral:
Securing a loan by pledging specific collateral gives the lender a secondary source of repayment. In the traditional banking industry, unsecured loans are the exception, available only to the strongest borrowers. The simplest form is a car loan: the loan is secured by a lien on the auto title; if you don’t make the payments, the lender will repossess the vehicle. For businesses, this is frequently a UCC lien on all-assets of the business, or a lien on the specific equipment being purchased with the loan proceeds.
- Character:
The Borrower’s personal character and integrity, credit history (business and personal) as well as work experience, both industry and management.
A part of Character is the separate issue of Personal Guarantees. Business owners ask: “Why do I personally have to guarantee to repay the loan if the business is not able to do so?” The Banker responds with the question: “Why would I want to lend money to someone who won’t promise to pay me back?”.
- Communication:
Yes, it says Five C’s, but a successful relationship with a banker also requires a willingness to communicate openly and frankly with your banker. A reluctance to share bad news can be interpreted as a character deficiency: Lying by omission does not give your banker a warm, fuzzy feeling about your relationship. Good relationships are always founded upon clear and open communication.
Call us if you would like to learn more about how banks evaluate customers (Borrowers). We can coach you about specific ratios used, what they mean and why they are important, both to the banker, and to you.