Your business has started to take off and you need additional capital to hire a new employee, expand into a new space, and possibly purchase some additional equipment, so you start to search out financing from your local commercial bank. You walk in, expecting them to decide to help you out on-the-spot, because look at how great business is going! However, it’s never quite as simple as you expected.
We talked to commercial banker, Benjamin Martin, to get his answer to the question “How do I get a loan for my business?”
He broke down for us some of the evaluation criteria and questions lenders ask to to assess the risk of working with a small business in his overview of the 5 C’s of Commercial Credit: Character, Capacity, Capital, Conditions, and Collateral.
Character – When a bank is providing financing, they are starting a relationship with the business – one that goes beyond just transactional. Lenders will typically discuss internally whether a company is one that the bank would want to be affiliated with — are you trustworthy? Do you follow through with your commitments? Is your company worth the partnership and the risk at hand? Do you have sufficient experience in the industry to grow, and to eventually repay the loan?
Personal and business credit history will provide a helpful, although limited, picture of use of credit in the past, so answers to these questions will provide additional insight about the business and the lending opportunity.
Capacity – Lenders will look at three tiers of repayment. The primary source of repayment in many cases is your company’s ability to generate enough cash flow to pay its obligations. As was noted above, personal and business credit history can be used as an indicator of future payment performance, but the business projections can also influence the conversation.
Lenders will also assess the risk of not being repaid on a loan. If the ability to repay is limited, a bank will look at secondary sources: Company owner’s personal assets, liquidity, and outside personal net worth (such as real estate, fixed assets, etc.) As a worst case scenario, banks will look at a tertiary source of repayment, many times as liquidation/repossession of collateral.
Capital – Lenders will use a Loan-to-Value (LTV) calculation to determine how much cash/capital has been invested. Have you invested capital wisely into the company operations? On lower risk transactions, Lenders might allow less capital to be injected, as the bank is absorbing less risk as a result. However, on higher risk transactions – for example, lending on specialized equipment which would be difficult to re-sell, lending on vacant land, etc. — Lenders may require more capital so that you show that you also are absorbing risk in the financing.
Lenders want to establish relationships and partnerships with their clients; unless a loan is secured 100% with cash, a bank will require some form of equity so it is not providing 100% LTV financing.
Conditions — Is your company sustainable and have you done adequate research on the industry, or have adequate experience? Have economic conditions been considered and is the business “recession proof”? Have appropriate steps been taken to absorb any downturn in an industry/national/state economy?
There are certain industries to which Lenders traditionally have great difficulty lending: Restaurants, Dispensaries, Adult Entertainment, and highly specialized companies where collateral may be difficult to re-sell. It may take alternative financing options to get a loan for your business.
Collateral – The final “C” is Collateral or Security on a loan. Lenders must assess the risk on collateral as much as the risk in other parts of the credit request. The more equity you have in your assets, the more valuable they are to pledge as collateral. As is noted in ‘Capital’, the bank must margin (or discount) the collateral according to its strength. For example, a building that you may own where you also operate your business would be considered stronger collateral; the bank would lend more based on that value. Keep in mind, however, that a bank doesn’t want to take your assets to collect on the money, but they need the security that repayment will occur.
About the Advisor
Benjamin Martin has been in Denver’s banking community since 2001, serving both consumer and commercial clients as is currently at Solera National Bank. He enjoys working with all types of clients, from medical, to construction, to real estate, and everything in between. You can contact Benjamin at BMartin@solerabank.com
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