The Five C’s

So you want to understand how a banker thinks and how he looks at your loan request? Well, Lending 101 dictates that he begins with the Five C’s: Character, Capacity, Capital, Conditions, and Collateral. What do these nebulous terms mean? Well, here is a simple explanation of each of these terms:

Character – Simply put, your banker will want to know that you will do everything humanly possible to repay your loan. If that means tightening your belt and making personal sacrifices in the name of the business, then all the better. Bankers will pull credit reports on both you and your business to determine how you’ve handled previous debt obligations. Also, they might pull reports to see if you’ve been involved in litigation with suppliers, customers, or lenders.

Capacity – How much debt can you handle? This depends on how much cash your company generates or is projected to generate. With good reason, banks tend to discount projections and forecasts if they differ from historical performance. Bankers calculate your ability to repay your loan based on financial ratios. These ratios are often calculated based on previous years’ profitability and cash flow.

Capital – How well-capitalized is your company? In short, how much “skin in the game” do you as the owner have? If you expect the bank to lend, you better well have some of you own money or equity in the company. Think about it. If your friend had a great business idea and wanted to borrow money from you, you would want to know if he was willing to risk some of his own money. It’s not realistic or prudent to expect someone to risk only other people’s money.

Conditions – Even if your company is sound and your prospects seem good, the conditions of the industry or economy are important to bankers. Even if you are the market leader in typewriters, if the industry is shrinking, your company will probably do the same. Similarly, if you provide construction services and the real estate market has tanked, chances are your business will suffer.

Collateral – Often, bankers will want some form of collateral as a back-up plan should you not make good on your loan payments. Bankers often have a much lower estimate of collateral value than you might. That is because banks must often liquidate collateral at fire-sale prices. In addition to hard assets such as real estate and equipment, banks will consider accounts receivable and inventory as potential collateral.