You’ve perfected your business model and are ready to launch. Or, maybe you’re ready to expand beyond your current geographic reach. Regardless of what business stage you’re in, if you need a small business loan, knowing the 5 Cs of credit can help you be better prepared for a small business loan application.
In this overview, you’ll learn about the 5 Cs of credit and how you can use them to put your best application forward.
What are the 5 Cs of credit?
The 5 Cs of credit are a common way to refer to the key points lenders review when considering a loan application, which are capacity, character, capital, collateral, and conditions.
Together, these factors determine whether you can handle additional debt and the likelihood of repayment.
How can the 5 Cs of Credit increase your approval odds?
Let’s take a look at each of the 5 Cs and tips to help you leverage them during the loan process.
1. Capacity
Capacity is the ability of your business’s cash flow to cover the annual payments of existing or new loans. This means that between your current and projected income (from a new or expanding business), you’ll be able to pay existing and new debt from a loan, if you’re approved.
As a result, it’s one of the most important factors that lenders consider. Pursuit determines your capacity by reviewing your earnings before interest, taxes, depreciation, and amortization (EBITDA).
What can you do to improve your capacity?
Before applying for a small business loan, calculate your EBITDA – you should base this on a recent or projected period – and see if your cash flow is strong enough to support existing payments and a future loan. There are strategies you can take to strengthen your cash flow, like improving cash inflow or reducing expenses.
2. Character
For lenders, character means demonstrating a good history of responsible credit management. As a result, it’s also one of the most important of the 5 Cs. Lenders will look at your credit history to see past credit-related debt and repayment history, and for most small businesses, your personal credit history will be the source of information.
Your personal credit report is pulled from the major credit-reporting agencies, such as Experian, Equifax, and TransUnion. The resulting score is called a FICO score, and lenders usually have a minimum score required for loan approval—although not all lenders use the same minimum score.
What can you do to improve your character?
It’s a good idea to review your credit report before applying for a loan. That way, any potential errors can be corrected before a lender pulls your history, and if needed, you can work to improve your credit score. You can also spot issues, like late payments, that will cause your FICO score to be lower. You can address this by making on-time payments for several months or until the debts are paid off.
You can get a free report annually from each agency, and it’s a good idea to request all of them. Sometimes, the information will vary from agency to agency, and you likely won’t know which agency a potential lender may use.
3. Capital
Capital is the amount of money you can contribute toward a loan deal, and responsible lenders will require a contribution from you. That’s because having “skin in the game” – contributing your own money – reduces the amount a lender needs to give you and tends to make borrowers repay loans more responsibly.
However, the amount of capital you may need can vary significantly based on each lender’s criteria and the loan purpose, so it’s important to research loan options in this area.
What can you do to improve your capital?
Knowing that you need to contribute to your loan deal means that you should start identifying your source of funds as soon as possible. This can be personal savings, a home-equity loan, or a loan or gift from a family member or friend.
Researching loan options well ahead of needing a loan can help you determine how much you’ll need. For example, banks may require a 30-40% owner contribution toward a loan deal, while a Community Development Financial Institution (CDFI) may only require 10-15% toward loans.
4. Collateral
When a lender requires assets to secure a loan, they need collateral. Depending on the situation, the items used as collateral may be the same thing that the loan is used to purchase, like with a commercial property or major equipment for a business. In other cases, you may be asked to offer personal property, such as a home, car, or boat, to secure a loan.
What can you do to improve your collateral?
It’s important to know your options before you apply – not all loans need collateral, and it usually depends on the loan type, amount, and lender criteria. For example, if you need a business loan of $10,000 or $20,000 to purchase inventory or office equipment, you may not need to pledge your home, while a $300,000 loan to launch a restaurant will likely require something to secure it.
Before you apply, figure out what you need (the amount and uses). This will give you a sense of what could be used as collateral, if required, and what you may need to secure it. If you don’t have any personal collateral to secure a loan, know that unsecured loans are available. Still, they typically need extra research to ensure you’re working with a responsible lender and won’t get your financials tied up in a bad deal.
5. Conditions
Conditions can include factors within your industry or geographic region that impact your business, as well as the loan structure. For example, lenders may tweak a decision because you requested a 10-year loan, but plan to lease a space for only five years.
Let’s say you want to launch a restaurant that needs to serve 100 people daily to break even, but you’re located in a small town of just 1,000 people. You’ll need to show why that will work – perhaps your location will be on a busy roadway that many travelers use to pass through your town daily.
What can you do to improve your conditions?
For the most part, there isn’t much you can do to change the economic conditions around your industry or the country. It’s also up to the lender to make the approval conditions of the loan appropriate for your use.
It’s a good idea to research potential lenders and find one who’s willing to work with you and is dedicated to your success.
What lenders are looking for
Whether you’re in the planning stages for a new business or ready to grow, financing is essential. Help lenders help you by preparing a thoughtful, thorough, and well-researched business plan and financial projections.
If your business is in the pre-launch phase, you’ll need to support your projections through your research. If your business currently exists, you’ll need to support it through information pulled from your business’s history, including the five essential financial documents.
When you’re ready to apply, Pursuit can help
Now that you know the 5 Cs of credit and what you need to do to get ready for a loan application, take a look at the small business loan options from Pursuit.
With loans from $10,000 to $5.5 million, we have financing for working capital, equipment, the purchase or construction of commercial real estate, to refinance business debt, and more for businesses in New York, New Jersey, Pennsylvania, Connecticut, Illinois, Nevada, and Washington.
Start your application today!