Capacity or cash flow represents your ability to generate income that will pay your debts. If you’re starting a new business, the bank assesses your global cash flow – your current personal income as well as your projected income from the business. If you’re acquiring an existing company, the lender wants to see that the last three years of business tax returns reflect positive cash flow and profit.
The bank won’t give you money if it sees no evidence that you can repay it. Your capacity is an important part of the evaluation process for the loan. If you don’t have sufficient capacity, you can consider bringing on a partner to add cash flow to the scenario.
Character isn’t a question of your personal charm – it’s your business character the bank will assess. What’s your experience in business in general, and in the industry in which your new business will operate? Have you managed profits and losses successfully in your previous business or for an employer? Have you worked your way up through an industry and gained experience in multiple aspects of its operations?
Your loan application should draw from the same work you do when preparing your business plan – detailing your experience and the skills necessary to run your business.
The bank does care about some aspects of your personal history as well. Would-be borrowers are often surprised to learn that they must provide information on any current criminal charges they are subject to, any recent arrests on charges, any convictions or guilty pleas in their history, if they are at least a 50 percent owner in the applicant business, and whether they are delinquent on child support.
Entrepreneurs should also be aware of a bank’s stance on collateral. Most banks expect its loans to be fully secured, but will not generally decline a loan based on inadequate collateral, assuming the borrower satisfies the other standards for capital, credit, capacity and character. However, if you have what a lending institution terms “worthwhile assets,” then the lending bank will require they be used as security for the loan.
In particular, if you own a home with a value of greater than 20 percent equity, the bank will take a lien against your home as security for the business loan, whereas if you don’t own a home and meet all other loan criteria, the bank will likely approve your loan unsecured. It can be unpleasant for entrepreneurs with a more solid financial base to discover that they are required to take on more risk than some of their peers.
It can particularly put business partners into conflict with one another if one has a qualifying equity stake in a home and the other does not, since the home-owning partner will be required to assume this risk to proceed with the loan application.
What are non-negotiable qualifications to obtain a business loan? Banks are currently looking for personal credit ratings in the high 600s and up. Recent bankruptcies, or no evidence of cash flow, are also general deal-breakers.
Entrepreneurs should remember every bank or lender interprets regulations a little differently. Entrepreneurs turned down by one lender should, if they have a strong business case, keep searching.
As always, consult a financial professional before entering into the application process. Experts can save you time and frustration by helping you understand (and, if necessary, improve) your position. Have your accounting in order, and then make sure you’re aligning yourself with the right partners who want to help you succeed, and aren’t in a trap of unfavorable loans with interest rates that can cripple business right out of the gate.
The 5 C’s aren’t just barriers to overcome to fund your dream – they are the path to bankability. When the 5 C’s align for the bank, there’s a much better chance they’ll align for the success of your business as well. If you have your 5 C’s lined up, ask about our Loans 4 Biz program. Emerald Coast Business Intermediaries partners with over 65 lenders in helping to buy good businesses.