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The 5 C's of business credit that alert lenders

Dawn Papandrea

February 2, 2015

You've established your business credit and are ready to really ramp things up.

Maybe you need a loan to expand or you need to lease equipment. In order to determine if your business is creditworthy, lenders and vendors will not only look at financial statements; they may look at the company owner's personal credit file as well as the business's credit file when reviewing applications, says Jordan Peterson, credit product manager of PNC's Business Banking division. Essentially, he says, if applying for a loan, lenders will put your business to the test to see if it meets what is called in the business loans industry the “5 C's of Credit.”

Take a look at what those five pieces of credit criteria are, and why they are important to achieve in order to take your business to the next level.

1. Character

Your “credit character” is best conveyed by your credit history. This is where information from the credit bureaus comes into play, says Peterson, as it will provide a snapshot of your business dealings, as well as how you've handled your personal finances. “How have you behaved in the past with whatever credit you've been granted on a personal and professional level?” asks Mitchell D. Weiss, professor of finance at the University of Hartford, and author of “Business Happens: A Practical Guide for Small Businesses and Professional Practices.” “Lenders want to be dealing with someone who is inclined to pay back the loan. If the record is clean, one can make a leap of faith that the borrower is going to behave that way in the future.”

“If you do all these things and honor your obligations and are responsible, then the odds are you are building a business that's going to endure.”
–Mitchell D. Weiss, University of Hartford

That's not to say that if you've faced struggles in the past that you're doomed. “If there is something in your background on a personal or business credit report, be forthcoming about it and disclose it up front,” says Weiss. Especially nowadays, with so much information available online, loan officers can easily find delinquencies, defaults and bankruptcies. If they find someone withholding information, that doesn't bode well for the application, adds Weiss.

In fact, if you experienced financial difficulties in the past and overcame them, you should wear that as a badge of honor. “For example, if your business took a hit in 2008-2009 like everyone else and you've gotten past that, be proud of that,” says Weiss.

2. Capacity

Capacity is perhaps the most important factor for a lender since it has to do with the borrower's financial muscle — in other words, if the business makes enough money to carry the weight of the debt. “Capacity covers the business' ability to repay, specifically, what the cash flow of the business is like,” says Peterson. This factor will not only determine if an application will go through, but for how much, says Weiss. “Once lenders decide that they will do business with you, they will move on to figuring out how much they are comfortable lending,” says Weiss. Naturally, this decision should be directly related to the cash you have coming in.

3. Capital

Besides cash flow, another important aspect of business credit is capital, says Peterson. “How much money has the business owner put into the company? How many assets does he/she have?” he explains. In other words, how personally invested are you in your business, and how much of it do you own versus what you owe? It's important that you have equity in your company to show that you aren't one bad quarter away from disaster. Plus, the more personally invested someone is, the harder that person will likely work to help the business thrive.

“No lender wants to be the only one with 'skin in the game,'” says Weiss.

4. Conditions

There are some factors that are ultimately beyond your control, says Peterson, but savvy lenders have to consider those as well. “Lenders will ask: 'What are the economic conditions, and what kind of industry is the business in?'” says Peterson. From a bank's perspective, even a creditworthy borrower could fall victim to the economic environment or a big industry shift, says Weiss. “What lenders want to know is could you sustain a downturn, as well as can the business quickly act in a controlled way, whether there is a good or bad situation?” he says. In other words, even if conditions allow for a growth opportunity, lenders want to feel comfortable that the business concept is solid enough to withstand and rebound from any economic stress.

5. Collateral

“Lenders always want to have a second way of getting the loan repaid,” says Peterson. After cash flow, the next best thing is collateral, so that the lender has a safety net for getting back its investment. Usually it will involve the business having to liquidate some of its assets. It's also what you stand to lose in the event of a default, says Weiss, which is why he urges business owners to pay careful attention to the default clause in a loan or lease contract. “You want to understand what's required of you, timely payments for example; what constitutes a default, whether in the form of nonpayment or breach of contract; and how can that default be remedied and how much time you have to do that,” he says.

Once you've built your business credit to the point of achieving the 5 Cs, the obvious payoff is access to more credit at more reasonable rates, says Weiss. The non-obvious benefit? You've developed a sustainable business.

“If you do all these things and honor your obligations and are responsible,” says Weiss, “then the odds are you are building a business that's going to endure.”