The 5 C’s of Credit and What They Mean for Your Business Loan

One of the most customizable divisions in banking is commercial or business lending. Residential loans, such as mortgages or home equity loans, adhere to strict government, regulatory, and industry criteria and pricing structures. There is very little room to develop a customized loan program. Businesses, however, are a completely different story. Businesses are unique in nature, each one different from the other, which is why commercial loans are so uniquely designed. These loans take time to appropriately structure and involve a lot of considerations, so it’s wise to partner with a bank that listens to your needs and works to accommodate them. Your business needs a partner, one that will listen and take the time to get to know you and your business.

The most common questions we receive from business owners seeking financing are: “What will the bank be looking for from me and my business?”, “What does my business need to obtain a loan?”, and “How will a bank approve my business loan?” While each lending situation is unique, many banks utilize some variation of evaluating the “Five C’s of Credit” when making credit decisions: Character, Capacity, Capital, Conditions, and Collateral. We’ll take a look at each of these considerations and how they may impact your funding request. Review each category and see how you stack up.

What is the character of the management of the company? What is management’s reputation in the industry and the community? Investors want to put their money with those who have impeccable credentials and references. The way you treat your employees and customers, the way you take responsibility, your timeliness in fulfilling your obligations — these are all part of the character question.

Character is really about you and your personal leadership. How you lead yourself and conduct both your business and personal life gives the lender a clue about how you are likely to handle leadership as a CEO. It’s a banker’s responsibility to look at the downside of making a loan. Your character immediately comes into play if there is a business crisis, for example. As small business owners, we place our personal stamp on everything that affects our companies. Often, banks do not even differentiate between us and our businesses. This is one of the reasons why the credit scoring process evolved, with a large component being our personal credit history.

What is your company’s borrowing history and track record of repayment? How much debt can your company handle? Will you be able to honor the obligation and repay the debt? There are numerous financial benchmarks, such as debt and liquidity ratios, that investors evaluate before advancing funds. Become familiar with the expected pattern in your industry. Some industries can take a higher debt load; others may operate with less liquidity.

How well-capitalized is your company? How much money have you invested in the business? Investors often want to see that you have a financial commitment and that you have put yourself at risk in the company. Both your company’s financial statements and your personal credit are keys to the capital question. If the company is operating with a negative net worth, for example, will you be prepared to add more of your own money? How far will your personal resources support both you and the business as it is growing? If the company has not yet made profits, this may be offset by an excellent customer list and payment history. All of these issues intertwine, and you want to ensure that the bank perceives the business as solid.

What are the current economic conditions and how does your company fit in? If your business is sensitive to economic downturns, for example, the bank wants a comfort level that you’re managing productivity and expenses. What are the trends for your industry, and how does your company fit within them? Are there any economic or political hot potatoes that could negatively impact the growth of your business?

While cash flow will nearly always be the primary source of repayment of a loan, bankers look at what they call the secondary source of repayment. Collateral represents assets that the company pledges as an alternate repayment source for the loan. Most collateral is in the form of hard assets, such as real estate and office or manufacturing equipment. Alternatively, your accounts receivable and inventory can be pledged as collateral.

The collateral issue is a bigger challenge for service businesses as they have fewer hard assets to pledge. Until your business is proven, you’re nearly always going to pledge collateral. If it doesn’t come from your business, the bank will look to your personal assets. This clearly has its risks — you don’t want to be in a situation where you can lose your house because a business loan has become strained. If you want to be borrowing from banks or other lenders, you need to give careful consideration about how you’ll handle this collateral question.

Keep in Mind…
Keep in mind that in evaluating the “Five C’s of Credit,” investors don’t give equal weight to each area. Lenders are cautious, and one very weak area could offset all the other strengths you show. For example, if your industry is sensitive to economic swings, your company may have difficulty getting a loan during an economic downturn — even if all other factors are strong. And if you’re not perceived as a person of character and integrity, there’s little likelihood you’ll receive a loan, no matter how good your financial statements may be. As you can see, lenders evaluate your company as a total package, which is often more than the sum of the parts. The biggest element, however, will always be you.

Community Banks: Why Their Financing Process Benefits Most Local Businesses
As shown above, there are several factors banks consider when offering a business a loan, and the process can be time consuming. Most small businesses (under 500 employees) benefit from the personal attention and flexibility community banks, like Standard Bank, can offer. You work with one Relationship Manager throughout the entire process, and that Relationship Manager has direct access to not only the Chief Commercial Lending Officer, but the bank CEO as well. Our teams are smaller, and therefore, more efficient with timely decisions and processing. With Standard Bank, we offer an ear before an answer and ensure you are comfortable and informed as you move through the borrowing process. Our customers are more than what they can put down on a paper form, and we want to manage a relationship with them. We finance small short-term loans to long-term, multi-million dollar solutions. At the end of the day, when it comes to commercial lending, be sure to choose a bank you can consider a partner. A bank that’s on your side. A bank that listens. A bank that helps your business grow.