If you’re applying for a small business loan, you’re going to want to establish a strong relationship with a financial lender. They have the money. You need the money. So it’s a good idea to know what to expect in the loan application process. Here’s what banks are looking for in a potential candidate.
1. Character
The bank will interview and analyze you based on how trustworthy you are. It’s kind of like talking to a potential girlfriend’s father who asks “Why should I let you date my daughter?” But, in this case, it’s the bank asking “Why should I let you borrow my money?”
In the character assessment phase, a bank sizes up your business sense, your business references and your overall business experience. Basically, you need to show the bank you know your stuff backwards and forwards, as well as having a track record as a capable business leader.
2. Credit Score
This one’s basically a prerequisite to applying: is your personal and business credit history strong or does it need help? A bank isn’t looking for a candidate for “most improved”; they’re looking for someone who’s a perennial all-star of fulfilling financial commitments.
A good credit score (high 600’s and better) is a crucial consideration to successfully receive a small business loan. However, if your score is less-than-perfect, a bank can still be willing to loan you money, depending on the circumstances of your score. When you’re just starting out a new business, your personal credit score is most important--if you have a history of paying off your credit cards and loans on time, you’ll set yourself up for success.
3. Capacity
Simply put: are you able to pay back the loan you’re requesting? This comes down to cash flow. In this phase, the bank will assess your personal income as well as your business’ projected income. The numbers don’t lie--if you have the potential to pay the loan back, you’ll be in good shape; if you don’t, it’s not the end of the world. Consider adding a partner (or two) to your venture as a way of increasing your business’ capacity.
4. Capital
This is a measure of how willing you are to put your personal finances on the line in order to make your business successful. A bank will not fund any business completely; for a new business, lenders usually require the loan applicant put a minimum of 20% down, and the bank will cover the other 80%. So, if you’re short on cash, this is another reason to consider adding a partner (or partners) to your business.
5. Collateral
Your potential lender could very well attempt to secure your house or major equipment as collateral. If you own over 20% equity in your home, the bank can put a lien on your house as a way to secure their money. Of course, your lender could also use anything they deem a “worthwhile asset” (anything from equipment to inventory) to secure your loan. Not all banks see collateral equally, you should be prepared to answer the collateral question.
Once you have a solid grasp of the Five C’s, you actually have to prepare a business plan and go through the application process. However, knowing the Five C’s will set your business up well to find favor with your bank.