by Kristi Price, Georgia SBDC Need funding for your small business without the hassle? Watch your Cs and Qs! Have you ever purchased a car or a home? If so, you are probably all too familiar with the personal loan process and the frustration that it can bring. Contrary to general public perception, the loan process for small business owners is certainly no less challenging. In fact, depending upon the level of risk involved, small business owners often face a much greater level of difficulty in obtaining loan funds. In the past, the Small Business Administration (SBA) actually served as a lending institution and provided funding for commercial ventures. However, the SBA now acts primarily as a guarantee agency for small businesses. Typically, a small business owner must apply for a loan through a commercial lender. If the lender endorses the business idea but is not completely comfortable with the level of risk involved, the lender may request an SBA guarantee before approving the loan. Ideally, the SBA guarantee lends credibility to the borrower and places the SBA in a position to assume a percentage of the loan risk. Because commercial lenders are the primary source for most small business loans, it is important to understand the criteria on which these lenders base their decisions: the five Cs of credit. These include character, capital, collateral, capacity and condition. Small business owners should evaluate each of these criteria prior to approaching a lending institution. "Character" is possibly the most critical aspect of loan approval. In essence, character refers to a borrower's willingness and ability to repay a loan, determined largely by a borrower's credit history. Typically, the initial phase in the loan application process involves the request for a credit report. If a credit report reveals bankruptcy, late payments, public collection issues, or other negative information, lenders will often deny a loan application without further consideration. In the absence of a strong credit rating, the lender may require additional capital or collateral or may offer shorter terms and/or higher interest rates. As a rule of thumb, small business owners should obtain a copy of their credit report at least twice a year and always prior to completing a loan application. Then the owner has an opportunity to clear up errors and/or discrepancies and avoid denial based on false information. Maintaining good credit and ensuring accurate reporting of credit history is an individual responsibility. It is the first and most vital step toward receiving loan approval. "Capital" involves the amount of cash or equity that a borrower intends to inject into the business in the initial stages. For start-up businesses, lenders generally expect a minimum injection of 15-20% of the total project costs. From the lender's perspective, this kind of commitment ensures that the potential borrower has a vested stake in the business and thus an incentive to succeed. "Collateral" refers to any physical property or assets that may be pledged as a secondary source of repayment for a loan. It commonly takes the form of real estate, equipment, inventory, stock, etc. Lenders often seek 75% or more collateral for small business loans. In the absence of sufficient collateral, a lender may solicit an SBA guarantee in order to approve the loan. "Capacity" may also be known as cash flow. Loan repayment necessitates sufficient cash flow. Existing businesses may demonstrate capacity through historical financial statements; however, start-ups must provide cash flow projections accompanied by supporting documentation. Three-year projections are standard and should be delineated by month for the first year and by quarter for the second and third years. "Condition" encompasses all external factors that may affect a borrower's ability to repay a loan. Such factors may include changes in a specific industry, overall economic trends, technology, and competition in the marketplace. Armed with a clear understanding of the Cs, small business owners can significantly minimize the obstacles to obtaining loan approval. Get ready, set and go for it! To obtain small business assistance contact a consultant at a Small Business DevelopmentCenter.
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