Lending Packages and the 5 C’s of Lending
As a borrower, there are many moving parts to a business loan. Maybe you need a short term working capital loan, a line of credit, a piece of equipment or millions for a new location. Whatever the needs, lending packages are not cookie cutter and there is no standard checklist.
Banks refer to the 5 C’s of Lending as a checklist, but I have never assisted a client in closing a loan that had all 5 in perfect order.
- Capacity – The ability to repay the loan or service the debt.
- Capital – the money you or your business invest into the lending package or “skin in the game”
- Collateral – Basically something the bank can take if the debt is not serviced and the Guarantee is the signature of you and potentially another party will to guarantee you loan.
- Conditions – Reason for lending and the conditions of the business, economy or industry.
- Character – A subjective opinion of the lender based on your education, business experiences, community involvement, references and personal history.
The Lending Package
Banks typical first requests are: 3 years of personal or business tax returns, a credit report and a personal financial statement to determine personal net worth. Providing net worth is adequate, they will request remaining documents.
When I am assisting with a lending package of which the 5 C’s are not perfect, I want the bank to see the business plan before the credit report, PFS or the taxes. You want the bank to fall in love with your plan or idea before they base their sole decision on tax returns. Maybe your business has landed a big contract that will not show up on historical data or maybe a competitor went out of business and the client is seeing a surge in sales that will not show up on historical data.
The bank may eventually want to see:
- Business Plan
- Financial Projections
- Financial Actuals (if existing or buying)
- Uses and Sources
- Quotes and Appraisals to Support Uses and Sources
- If Leasing – Lease Agreement
- Credit Report and Score
- 3 Years of Personal and/or Business Tax Returns
- Personal Financial Statement
- Industry Reports
Weaknesses of the Lending Package
- Credit Score is less than 700 – instantly this may make you think you are not lendable or this is not a strong package. This is not always the case. You have to dig into the credit report and find out what makes the score low.
- Is the bad debt over 5 years old?
- Is it one bad debt that can be explained (medical or divorce)?
- Is it too many credit inquiries?
- Clients Tax Returns Show a Loss– is it creative accounting done by your accountant to insure less taxes are paid? Do the Quick Books (or accounting docs) match the tax returns?
- Borrowing for a new business but the client has never been a small business owner– What other experiences do you have that will assist them in running this business? Who are your mentors? Who are the members of your professional support systems or Advisory Board?
- Collateral – If you are opening a business in leased space and the loan is for equipment, this type of lending is tough to count as collateral. The bank does not want to own equipment. This type of loan will likely require a personal guarantor.
- Lack of Skin in the Game – Can you use equity in a building as capital? Can you borrow from friends, family, a 401K or personal savings?
- You are quitting your current job – This is a concern for the lender because the bank wants to know how the debt will be serviced if the business fails. Can you keep your job? Can you find a personal guarantor with a job that supports the debt?
You may and should negotiate the terms of lending
- Creditworthiness gives you leverage
- Money or Skin in the Game gives you leverage
- Existing business with success and profitability gives you leverage
- Equity or Collateral gives you leverage
- Community need and community profile will give you leverage
What can you negotiate?
- Interest rate
- Term limits
- Maturity Date
- Early Payoff Penalties
- Personal Guaranty
- Closing Costs and Fees
Possible Client Cases
Startup Restaurant – Bank Loan $180,000.00 and Community Revolving Loan $75,000.00
The borrower had previous experience owning a restaurant, the borrower has a credit score of 760, she had $40,000.00 of her own money and the she was buying an existing building that was previously a restaurant. The building had two finished apartments above the restaurant that would count as income. The building would act as collateral. The borrower was quitting her job and the restaurant would be her sole source of income.
It took seven banks before the borrower could find a lender. The banks that turned down the loan stated the reason was either they didn’t lend to restaurants or they didn’t lend to start ups. The bank that finally lent to her required she find a personal guarantor.
Party Venue – Bank Loan of $180,000.00
The borrower’s credit score is 660, the borrower has one judgement from 6 years ago, and he has $20,000.00 skin in the game. The borrower has never owned a business. There were two borrowers and both were keeping their jobs. The borrowers made $140,000.00 between them and owned a home with equity.
The borrower was approved at the first bank and closed on their loan within 6 weeks.
If I were predicting, I would have assumed the restaurant would have been easy based upon the 5C’s of Lending and the Venue would have been hard. I mention this because the checklist does not exist. One final note, banking relationships are a key part of lending. Bankers are people and make decisions based on personality and their understanding of your business plan.