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A business idea without capital is like embarking on a road trip on just one gallon of gas with no options to fuel up along the way. In both scenarios, you’ll likely not get very far. Under-capitalization is one of the biggest reasons businesses fizzle out. Fortunately, with the right preparation and intel, entrepreneurs can dramatically increase their odds of getting a small-business loan to ensure they’re set up for success from the very start of the journey.
How do you do it? It’s as simple as remembering the five Cs, says Stacey Sanchez, a 20-year veteran of SBA lending and senior loan officer at leading alternative lender and non-profit CDC Small Business Finance.
The five Cs are: credit, cash flow, capital, character and collateral. Sanchez along with CDC’s business-advising team break down these major indicators and how they all affect your chances of getting business capital.
“It’s important to understand how all those things work together and how a lender is going to evaluate your loan request,” Sanchez said.
How’s your credit?
First things first, you’ll need to know what the minimum requirements are for the lender from which you plan to borrow. Arguably one of the most critical numbers they will consider is your FICO score, which ranges from 300 to 850. Traditional banks typically require about a 680 or more. Alternative lenders like CDC Small Business Finance, a non-profit that issues SBA loans and other loan products, requires at least a 620 score.
This figure is massively important because lenders consider it a reflection of how dependable you are when it comes to repaying debt.
“What we want to see is that you’re following through on your contractual obligations,” Sanchez said. “Are you paying your bills? Or are you letting things go into collection?”
Lenders also generally like to see that your debt-utilization ratio — calculated by dividing your credit card balance by your credit limit — is 30 percent or less. Lenders view anything more than that as a potential warning sign. Say you have $10,000 in available credit and you’ve used up $9,000, that’s a 90 percent utilization ratio. That’s far too high. If you have the cash available, pay your balance down to $3,000 or less.
“A simple way to increase your credit score is to pay down your revolving credit cards below 30 percent of your credit line,” said Ray Hivoral, a senior business advisor at CDC Small Business Finance.
Understandably, not all credit histories are blemish-free. And in many cases, this may not be an issue as long as you are up-front about past issues and you demonstrate past and present efforts to resolve them, Sanchez said.
Your business credit score is not as significant. But if you do have one, don’t hesitate to review it for any negative records such as liens, which can sink your chances of a securing a loan.
What’s your cash-flow situation?
As the saying goes, cash is king. If you want a loan, you’ll need to show you’re able to generate enough profit to repay it. There are two major ways to demonstrate this.
For existing businesses, it is key for them to have their taxes filed for the previous two years and have their interim financial statements to show income, said Marsel Watts, another CDC senior business advisor.
Additionally, you’ll want to provide historical business performance records and proof that you can support your normal household debt obligations along with the business loan you may get.
Startup businesses will need a complete business plan and realistic financial projections “to help us understand more in-depth the business and their capacity to pay us back,” said Eddie Landeros, also part of the business-advising team at CDC.
Do you have any capital?
When deciding whether to lend to a start-up, banks and other lenders will want to know how much equity is being put into the business. They’ll also want to know if you’ll be able to inject any equity as part of the loan agreement to “make sure you have skin in the game,” Sanchez said.
The amount you’ll have to inject as part of the loan depends on the lender’s criteria, loan program, the amount you plan to borrow, and whether you are acquiring an existing business or launching your own. There are certain situations where a lender will provide financing without an injection.
Do you have collateral?
This is particularly important for startup business owners seeking certain types of loans though it’s not always required. Collateral includes tangible items such as a home or business assets that can be sold off by the lender if you’re no longer able to repay the loan.
Collateral is also important if your business doesn’t show strong past profits. Additionally, if you do own a home that has equity in it, this can improve your chances of getting certain loans.
Don’t have collateral? Don’t panic. Loan products where collateral are not needed for approval do exist. They include loans administered through the SBA Community Advantage and SBA microloan programs.
Do you have good character?
While many of the factors involved in securing a business loan are numbers-based, this one is a bit more subjective. It’s the character of the loan applicant. For instance, loan officers like Sanchez place value on whether potential borrowers follow through on what they say – whether it’s a promised phone call, email reply, or a document. Lack of follow-up could be an indication of what’s to come.
“If you tell me you’ll get something to me today and I don’t hear from you in two weeks’ time, that tells me a lot about you,” she added.
Other important takeaways
Sanchez also imparted other dos and don’ts for potential borrowers to ensure they have a smooth loan process:
- Be specific about how much capital you need. When asked how much you’ll want to borrow, don’t say “as much as I can get,” she says. Loan officers want to know you’ve done the proper research and have a realistic range of how much capital you’ll need.
- Know exactly how you will use the money and why. Do know exactly why you need the funds and what it will go toward. An important part of the loan process is communicating the intended use of the funds, which can dictate what regulatory rules everyone will have to follow.
- Use free advising resources. Do take advantage of free or very low-cost resources mainly small business development centers, or SBDCs. They are funded by your taxpayers’ dollars by way of the SBA. Advisors at these centers can help you with everything from how to write an effective business plan to helping you set realistic projections. Another option is SCORE, another federally funded resource that offers free business counseling.
Are you loan ready? CDC Small Business Finance offers several loan options for business owners who want to grow their operations and are planning for their long-term needs.
Our loan experts will work to match you with a financing plan that best suits you. Let’s talk! Reach us at loaninfo@cdcloans.com or (619) 243-8667.
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