The five ‘c’s of small business lending and why you can’t ignore ‘c’ number five


Many lenders consider the Five ‘C’s (or a variation of the them) when evaluating a potential small business borrower for a loan:

  1. Character: This is a subjective measure that addresses your reputation and the reputation of your small business. Although this is a very important measure, many bankers ignore, or minimize the value, of this ‘C’ in favor of the other more tangible metrics. There are some small business lenders who give a lot of weight to this ‘C’ because most small businesses haven’t come out of the recession unscathed. Although it’s hard to evaluate, there are things you can do that give your banker a reason to look at more than just your credit score.
  2. Credit Score: One of the most important of the Five ‘C’s, every lender will look at your credit score when they evaluate you for a potential loan. Business owners of a young company will likely need to show their personal credit score as well as their business score (and yes, there are two scores). Depending on the lender, they all have a score threshold they will not go below. For example, the threshold for a bank is often significantly higher than that of an alternative lender—say 680 instead of 550.
  3. Capacity: This ‘C’ is particularly challenging for early-stage companies and start-ups. It’s difficult for anyone to offer a small business owner a loan if there’s no clear evidence they have the capacity to repay the loan. Most lenders will evaluate your ability by comparing your income against your recurring debt. Nobody wants to see you default on a loan, which is why an early-stage or idea-stage company with no product on the market to sell and no income has such a tough time securing financing.
  4. Capital: Most lenders want to see some skin in the game, which is the capital in this ‘C’. A significant financial contribution by the small business borrower lessens the likelihood of default.
  5. Collateral: Most of the time collateral is in the form of either property or larger assets like equipment. Collateral is one of the most important ‘C’s, which is why we’re talking about it today.

If we consider collateral in the context of a commercial real estate loan, it’s easy to wrap our heads around it. The collateral for the loan is the property we intend to purchase. If the small business owns real estate and needs a small business loan, in much the same way a homeowner would leverage the equity in their home to fund a second mortgage, a small business owner can leverage the equity in any property owned by the business to collateralize a small business loan.

The same is true with regards to an equipment loan. The equipment acts as collateral.

Many alternative lenders weight the ‘C’ of collateral as more relevant than some of the other ‘C’s. Which is why some small business owners who wouldn’t qualify based upon their credit score are able to get a loan based upon other criteria. An MCA loan, for example, uses the volume of a merchant’s credit card transactions as collateral. A factor, uses a small business’ accounts receivable as collateral. Next to credit score, the fifth ‘C’, collateral, is probably the biggest influencer regarding whether or not you’re able to successfully get a small business loan.

All five are important, but minimizing the value of collateral is a sure way to make sure you hear “no” at the bank. The right collateral is a great way to ensure a lender says, “yes.”

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