Lenders want to make loans. Loans are a main source of revenue for them. When speaking to a lender they will qualify that statement by saying that they want to make “good loans.” So what makes a good loan?
When going for funding you cannot over prepare:
- Prepare a well-written business plan. We here at the EDC can provide assistance and examples. Preparing a business plan should take some time and is a thoughtful process. A great resource is the entrepreneurial guidebook which can be found here.
- Establish a relationship with a lender. If you don’t have a relationship, start cultivating one now. And make sure the lender is friendly to small business.
- Know what your personal credit report looks like. All lenders will request a credit report – know what yours says. Credit reports can contain errors. Clear up any errors before going to the bank. If your credit report reflects unfavorable data, be prepared to discuss it. Don’t be caught off guard. You may request one free copy of your credit report each year from any one of the three major credit reporting agencies: Equifax, Experian or Trans Union. Or you may see all three scores at once.
- Know the Five Cs of Credit and how you stack up against them. These guidelines are the acid test for obtaining a loan.
The Five Cs of Credit
Your bank is in business to make money. Consequently, when a bank lends money it wants to ensure that it will be paid back. The bank must consider the Five 5 Cs of credit each time it makes a loan.
Capacity to repay is the most critical of the five factors. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the business; the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships – personal and commercial – is considered an indicator of future payment performance. Prospective lenders also will want to know about your contingent sources of repayment.
Capital is the money you personally have invested in the business and is an indication of how much you will lose should the business fail. Prospective lenders and investors will expect you to contribute your own assets and to undertake personal financial risk to establish the business before asking them to commit any funding. If you have a significant personal investment in the business you are more likely to do everything in your power to make the business successful.
Collateral or guarantees are additional forms of security you can provide the lender. If the business cannot repay its loan, the bank wants to know there is a second source of repayment. Assets such as equipment, buildings, accounts receivable, and in some cases, inventory, are considered possible sources of repayment if they are sold by the bank for cash. Both business and personal assets can be sources of collateral for a loan. A guarantee, on the other hand, is just that – someone else signs a guarantee document promising to repay the loan if you can’t. Most lenders may require such a guarantee in addition to collateral as security for a loan. A guarantor may be an individual, the Small Business Administration, US Department of Agriculture, or the Virginia Department of Business Assistance.
Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment or inventory? The lender will also consider the local economic climate and conditions both within your industry and in other industries that could affect your business.
Character is the personal impression you make on the potential lender or investor. The lender decides subjectively whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your educational background and experience in business and in your industry will be reviewed. The quality of your references and the background and experience of your employees will also be considered.