The Five C’s of Credit
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1. Capacity: How are you going to repay the loan?
Do You Know Cash Flow: Is your business making money? Most lenders require that your net income be at least
1.25 times the proposed debt payments. Here’s how to figure:
Your Credit
Net Income + Depreciation & Amortization
Score? ≥ 1.25
Proposed Loan Payments (Principal + Interest)
Payment History:
Personal Credit —Lenders usually require a small busi- What Goes Into a Credit Score?
ness owner to personally guarantee a loan. Know your credit
score, and protect your credit. Here are a couple of things you can
do to improve your personal credit: 1) Pay down debt; 2) Limit the
number of inquiries to your account; 3) Pay your bills on time, and
make sure you’re up -to-date on any loans, including student loans.
Business Credit – Are there large debts on your balance
sheet? If you have more debts than assets to pay them with, this
is a red flag to lenders.
Other Sources of Income: Is there another source of income in your household? Lenders will con-
sider other sources of income to be “backup” sources of repayment.
2. Collateral: What security can you provide?
Collateral is usually required for small business loans. You pledge an asset as security for the loan.
This chart shows the value of various forms of collateral:
Collateral Type Lender will value at:
House 75 – 80% of Market Value minus Mortgage Balance
Car Nothing
Truck/Heavy Equipment 50% of Depreciated Value
Office Equipment Nothing
Furniture & Fixtures 50% of Depreciated Value
Inventory: Perishables Nothing
Jewelry Nothing
IRA or 401(k) Nothing (unless rolled over using a FranPlan)
Receivables 75% of Receivables under 90 days
Stocks & Bonds 50% - 90%
Mutual Funds Nothing
CD 100%
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3. Capital: How much money have you invested in your business?
Prospective lenders and investors like to know that you have personally invested money in your busi-
ness. They also want to know that your business has enough extra capital to handle any unforeseen
needs. Most lenders and investors have a specific percentage that they require you to invest in your
business, and the range is usually 10 to 25% of the loan/investment amount. Loans for real estate
and fixed asset purchases usually require that you pay a certain amount toward the purchase, usual- TIP:
ly 10 —20%.
Part of your
documentation
for a loan will
include your
4. Conditions: How are you going to use the loan? Personal
Financial
Lenders will require that you provide details on how you’re going to use the money, and where you’re
Statement.
going to get all the money you will need. This is called a Sources and Uses of Funds Statement:
Remember:
Sources of Funds Uses of Funds
Bank loan $500,000 Equipment $250,000 Assets
Personal cash 100,000 200,000 (the current
Furnishings 50,000 value of
Working capital 100,000 everything you
own)
TOTAL $600,000 TOTAL $600,000
Lenders will also consider the history of your business and the economic outlook of your industry. If MINUS
your industry is especially sensitive to economic downturns, or your main products/services are sea-
sonal, you will need to show that you can handle productivity and costs to weather unforeseen
Liabilities
events.
(the current
balances of
everything you
owe)
5. Character: Who are you?
EQUALS
Do you have experience in your industry? Have you ever
managed a business, or supervised employees? What in
your educational and work background has qualified you to Your personal
run this business? Lenders want to know that you have net worth
the credentials and experience to run a successful busi-
ness. Having good references is critical.
Include in your documentation for the loan a copy of your
resume and the resumes of your top managers.
