I often describe myself as a “recovering banker.” I spent 20-plus years working within a financial institution, and let me tell you — banking practices and principles aren’t (and shouldn’t be) easily forgotten. In fact, I still apply what I learned as a banker over and over again in my career as a business advisor and fractional CFO. Today, I’d like to talk about a banking question that I often answer for my small business clients: What exactly does a commercial lender look for in a borrower?
Here’s my answer: The five C’s of Credit.
The five C’s are attributes that apply to both personal and commercial lending, but in slightly different ways. As you might guess, they all start with the letter “C”:
- Character,
- Capacity,
- Capital,
- Collateral, and
- Conditions.
Character is how you’ve managed your commercial and personal credit in the past; after all, past behavior is a good predictor of future actions. A lender will use both objective and subjective data to get a read on your character. They will review the concrete information in your credit history for both positive patterns and red flags, but they might also call your personal or business references and talk to you one-on-one to help them gauge your honesty and reliability.
Capacity is your ability to repay the loan. For business entities, this means reviewing your current cash flow. As a lender, I’d want to make sure that after you’ve covered all of your current expenses for the month — such as payroll, operating expenses, and existing debt — that you have enough revenue to make the projected payment on the loan for which you’re applying.
Capital is often referred to as “skin in the game.” Lenders want to know that you’re willing to invest some of your own money and/or assets into the business. Having equity in your business is an indication to lenders that you’re confident in your organization’s future and have more of an incentive not to default on a loan.
Collateral is an asset you pledge as a guarantee. In the event you default on repaying your loan, the financial institution can take ownership of your collateral to recoup their investment. If you’re borrowing funds to purchase something like equipment or real estate, those items are usually used as collateral. Other types of loans rely on your future assets (like accounts receivable and inventory) or revenues / cash flow.
Conditions are holistic indicators of your business’s potential for growth — and repayment. A lender will be familiar with economic conditions on all scales, from global to local, and they’ll use this information in their evaluation. They’ll also take the purpose of your loan into consideration — for example, if you’re looking for financing for a second location, they’ll review with you the feasibility of your expansion and its chances for success based on a variety of criteria.
I wish I could say that every decision a commercial lender makes is based on a quantitative formula or concrete checklist, but it’s just not true. Every loan is different, as is every lender and every applicant, so a cookie-cutter approach isn’t feasible — and that’s a good thing. Business owners deserve personal attention and an individual evaluation of their needs and creditworthiness. As a recovering banker-turned-advisor, I can leverage my network to find the right lender for you so you get the one-on-one experience you deserve.