External financing is typically the lifeline of a company, providing access to capital to purchase property and equipment, increase inventory, hire employees, and ultimately expand the business. Obtaining a business loan is about risk and relationships.
According to a panel of bank executives, the assessment of the degree of risk of a business is based upon various factors that are often entered into a formula. The factors are based upon both objective and subjective measures. If you have a pre-established relationship with your banker, your chances of obtaining the loan improve. However, before requesting a loan, you must be prepared with a viable business plan, sufficient cash flow to make loan repayments, adequate collateral, and a willingness to provide a personal guarantee for the loan.
Therefore, when it comes to commercial borrowing, it is important to remember the 7 C’s:
- Credit – The borrower must have good credit and any problems on the credit reports must be explained. There is a direct relationship between the owner’s personal credit history and the business’s credit history.
- Capacity – The business must be able to support its obligations and expenses, and generate a profit. Reliable financial information is a prerequisite. Audited financial statements carry much more weight than reviewed statements. Compiled financial statements provide little comfort to the lender.
- Capital – The business owner must have money or equity invested in the business. Banks prefer to lend to owners that have their own “skin in the game” and share the risk.
- Collateral – Banks want sufficient assets to secure the loan. Collateral is the secondary method of a loan repayment after cash flows. Collateral assets may be business or personal, and lenders discount the value of your collateral.
- Character – Without this, it is unlikely that the bank will provide the loan.
- Conditions – Are there any economic or industry trends that will affect your business? You must have a reasonable, comprehensive plan to address these conditions.
- Commitment – How committed is the owner to the business? Commitment comprises the ability and willingness to succeed which may involve personally guaranteeing the debt even if the company cannot pay it.
While understanding the 7 C’s may improve your business’s likelihood for obtaining a loan, there are several key points to maintaining a positive relationship with the bank.
First, remember that the bank is a partner in your business and wants you to be successful so that their loan will be repaid. Therefore, be straight-forward; don’t over- promise and under-deliver; and, to the extent possible, avoid last minute surprises.
Second, timely and accurate communication is critical to developing and maintaining trust. If conditions change in your business, develop your plan for addressing the change and discuss it with the bank.
Any forecasts or projections should be reasonable and consider different scenarios, including those most likely and the worst case. If you are projecting improved business performance, you need to be able to demonstrate how and why.
Lastly, surround yourself with other professional advisors (legal, accounting, insurance, etc.) that have your best interests in mind. They will challenge you, offer guidance, and assist you in achieving your goals.