The 5 C’s of Credit

How Business Lenders Evaluate Your Creditworthiness

When approaching a lender about a business loan, your viability as a borrower doesn’t begin and end with your credit score. Lenders look at a collection of factors when evaluating you as a potential borrower, a collection sometimes called The Five C’s of Credit.

Every lender weighs these factors differently, and you won’t necessarily need to dazzle your business lender on every front to be approved. You can, however, anticipate how lenders will evaluate the health of your business and fine-tune how to present your business in its best light. Understanding the Five C’s of Credit is a great place to start when looking for business financing.

Character

Lenders want responsible borrowers who can be trusted to honor their commitments. To assess your trustworthiness as a borrower, your lender will look at your credit report and evaluate your debt repayment history. This information is offered by the three major credit bureaus—Experian, TransUnion and Equifax— and credit reports contain detailed information about how much you have borrowed in the past and whether or not you repaid your loans on time.

Maintain a healthy credit score (of around 670 or above), and lenders will be more likely to view your business’s character favorably. If you aren’t already keeping an eye on your credit score, you can pick up a free copy of your credit report at AnnualCreditReport.com.

In addition, don’t neglect the more subjective components of your business’s character—things like the competence you convey when communicating with your lender. Even if your stellar bank statements speak for themselves, you should be able to speak confidently on behalf of your business, too.

Capacity

Sometimes identified as “cash flow,” this factor describes your ability to repay your loan. To determine your business’s capacity, your lender will look at the cash flow statements you submit with your application, and they’ll calculate your debt-to-income ratio to understand how your revenue or income compares to your current debts.

Remember that profit doesn’t necessarily signal positive cash flow. Work with an accountant on a cash flow analysis to learn more about how lenders will interpret your business’s capacity.

Capital

Lenders look favorably on business owners who’ve made financial investments in their business—investments like using personal capital to get your business off the ground, which you should communicate in your loan application. This kind of commitment tells your lender you’re serious about the success of your business and signals a decreased risk of defaulting on your loan.

If you’re approaching a lender to fund your new business without putting any of your own “skin in the game,” or if you launched your business entirely through startup funding and haven’t invested any personal capital since, you may need to rely on the strength of your other C’s to convince a lender of your creditworthiness.

Conditions

Your “conditions” as a borrower are affected by two factors: how you plan to use your loan, and the larger context of your business’s stability.

Be specific with your lender about how you plan to use your loan. Rather than giving them a general idea of your financial need, describe in detail the kind of growth your loan will enable, or the game-changing piece of equipment your loan will allow you to buy.

Your lender will also take a big-picture look at your industry and the economic climate to determine whether or not your business is a risky investment. This process could include analyzing your competitors, the stability of your suppliers, economic trends, and more. If your business serves a niche audience, ask your lender if they’ve serviced a business like yours before. If they haven’t, consider what kind of context you can provide in your application to help them view your business in the most favorable light.

Collateral

A lender offering you a secured loan (as opposed to an unsecured loan) will require you to offer collateral in the event you can’t repay your loan. Collateral, in this situation, means any business assets a lender could repossess if you default: real estate, inventory, equipment, accounts receivable, your house, etc.

If you’re considering an unsecured loan, don’t misinterpret the absence of a collateral requirement to mean there’s no risk of defaulting. Your lender may still sue you or demand other assets if you default on your unsecured loan. Consider these risks before choosing a loan product on the basis of your ability to provide collateral.

Lenders want to see confident business owners with reputations for being trustworthy, organized borrowers—ones that won’t waste their time and resources by breaking their commitments. Treat the Five C’s as your guide to becoming the kind of borrower lenders love to see.

Meredith is the Editor-in-Chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as SCORE, Fox Business, Amex OPEN, AllBusiness, and many more.