Accounting & Finance

The 5C’s of Small Business Lending

Written by Shaun McGowan

If you have begun to research business loans, you will know that there are scores of lenders out there offering business finance, from your high-street bank to the online ‘fintech’ providers producing fast applications and on-the-spot assessments.

With some lenders requiring several years’ solid trading and a top-tier credit rating, and others happy to offer second-chance finance to business with black marks on their credit record, it can seem as if each of these lenders uses different criteria to decide whether or not to offer a business loan.

However, that is not the case. Lenders all use some variation of the same simple equation to assess your application: does the reward they expect to receive sufficiently outweigh the risk of lending to you?

Finance providers’ tolerance levels (how much risk they are prepared to accept, and what level of reward will induce them to do so) do vary widely, but the assessment process still comes down to five fundamental criteria: the ‘Five Cs’ of business credit.

1. Character

Is yours the type of business they want to deal with?

Some lenders focus on businesses within a specific market sector (e.g. high-growth tech firms), while others have minimum turnover, trading history or credit rating requirements. If you do fall within their target customer base, you will probably also have to show your potential lender that yours is an established business likely to remain operational for the full duration of the loan.

More risk-averse lenders may want to make a thorough investigation into all aspects of your business, from your historical and projected financial performance to your strategic plans and market positioning. General economic conditions and the status of your industry may be taken into account, along with other factors like the skill level of your management team and the breadth of your customer base.

2. Collateral

Do you have assets you can offer as security?

A secured loan is a much lower-risk prospect for the lender, so if you have, property, land, vehicles or equipment to offer as collateral you can expect to find it easier to acquire business finance.

If your business does not own any such assets, you may be able to offer your personal property, like your house, as security. This can be a very risky strategy though – if your business fails you could end up losing your home at the same time as your source of income).

If you don’t have any collateral to offer you may still be able to get an unsecured business loan, especially if you approach an alternative lender. Expect to pay more in fees and interest to compensate for the increased risk.

3. Capital

How much capital is there in your business?

As part of their investigation into your character, your potential lender may want to see your balance sheet to establish the value of any assets or capital reserves your business owns. Even if you are not planning to put these up as collateral for your loan they can be significant (after all, a business with assets at least has something to sell if it is struggling to repay a loan).

Having capital invested in your business, rather than relying purely on debt finance, can also reassure a lender that you are fully committed to your business.

4. Capacity

Can you afford to repay your loan?

This comes down to whether you generate enough clear profits to make the repayments on the schedule proposed by your lender.

If the answer to this is no, none of the other criteria will really matter. Traditional lenders are strictly regulated and have to lend responsibly, so you’ll automatically be refused finance if you cannot show that you can comfortably service a loan. Even alternative lenders, who don’t operate under the same regulations and are often more tolerant of risk, need to have a reasonable level of assurance that you can meet repayments when they fall due.

Timing is crucial here – your business may be profitable on paper, but does that translate into actual cash in the bank at the time you need it? What happens if customers are late paying, or if interest rates rise? Do you have sufficient reserves to cover a temporary shortfall or to manage higher interest long term?

If not, then you may need to postpone your borrowing plans until your business is more established or consider non-debt finance like factoring.

5. Conditions

On what terms do you want to borrow?

Your repayment schedule is one of the loan conditions you may be to negotiate with a potential lender (for example, you may be able to make larger payments during your busy sales periods and minimal ‘holding’ payments during seasonal quiet times). Other loan terms include:

  • interest rate and type (fixed or variable)
  • how much you borrow
  • loan duration
  • flexibility to repay early or redraw funds
  • repayment set up interest only,or capital and interest

Varying the conditions of your loan can have a big impact on a lender’s decision – for example, they may consider your application more favourably if you are prepared to reduce the amount you borrow, make repayments more frequently, or pay a higher interest rate.

Some lenders may seek to impose restrictive conditions on your business to reduce their risk level (for example, limiting which customers you can deal with, or prohibiting you from offering vendor credit).

It is a smart idea to compare business loans and be sure that you fully understand all the terms, conditions and costs of your loan before committing to borrow – if in doubt, seek professional financial advice.

“The opinions expressed by BizWitty Contributors are their own, not those of BizCover and should not be relied upon in place of appropriate professional advice. Please read our full disclaimer."

About the author

Shaun McGowan

Shaun McGowan is a digital strategist and entrepreneur who has utilised his expertise to grow multi-million dollar businesses from the ground up. His philosophy is “domain name first; business concept second” premised on the firm belief that any successful business can be developed with the right online “real estate”.

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