Lenders use the six “C’s” of credit to understand your company’s full story and determine your ability to repay a small business loan as each one is a confidence builder and shows your ability to make payments each month and provide collateral so the lender can recoup their losses if you default. Choosing the right borrowers is one of the most important decisions for banks and alternative lenders because they make their money from interest paid on loans.
The six “C’s” of credit gives lenders confidence that you have the background and knowledge to invest the loan wisely and can repay it in full. By knowing what lenders look for across these 6 “C’s,” you can make your business loan application stand out and increase your chances of approval.
The 6 C’s of credit that lenders use for giving a business loan are:
1. Character
Character shows lenders the background context of a business, similar to how a resume works for job interviews. Qualities like educational history, business background, and industry expertise show your depth of knowledge about the industry you’re in and how to run a business. Business acumen and experience give the lender confidence that you can adapt to changing business environments and continue to make payments throughout the life of the loan.
On top of character, the total years your company has been in business, customer continuity and turnover, and how long you’ve lived at or operated out of your current address will also factor into the lender’s decision by showing them the stability of your business.
2. Capacity
Financial capacity shows lenders you have the cash flow and balance sheet to repay a loan, by demonstrating your history of debt repayments as well as the current debt you might be carrying. Lenders will look at 3 years or more of income statements, balance sheets, and cash flow statements to assess the financial health of the business.
Stable or growing top and bottom line numbers for the past few years show them the business can continue to operate smoothly, and healthy debt ratios prove you can handle new debt without risking bankruptcy.
Bonus-tip: Traditional lenders may not approve a small business loan for a brand-new business. Because you’re not producing revenue, you can’t show capacity to repay. If this happens, try an alternative lender or use equity financing over debt.
3. Capital
The third item lenders want to see is that you have capital for a deposit. This is both because it allows them to share their risk with you and because they must follow regulations like the Basel framework, which aims to keep the banking system safe and stable.
Deposits for loans are common practice across lenders, but the exact deposit required varies based on each lender’s internal guidelines and other loans they have made. Don’t be afraid to shop around since one lender might require a 20% deposit and another might only require 15% for the same loan.
If you don’t have capital for a deposit right now, try to free up cash with tax strategies like a Section 179 deduction together with bonus depreciation. Another option is to get documents from the lender on their policy and use them to apply for an SBA loan, since the SBA requires that you cannot find/qualify for financing elsewhere. SBA loans still require deposits, but they may be lower because it’s a government-backed program (i.e., the lender is already mitigating some risk).
Bonus-tip: You can use personal capital when needed by getting a home equity line of credit (HELOC), borrowing from your 401(K), doing a cash-out refinancing, or getting a personal loan to fund the deposit.
4. Collateral
Collateral is another way lenders manage their risk because, if you default, they can claim the collateral, sell it, and use the proceeds to recoup any losses from the loan. Loans like equipment financing and inventory financing have collateral built in because you’re using the loan to buy an asset. For other loans, you can put up a guaranteed asset such as:
- Business property like vehicles, machinery, or electronics.
- Financial assets like stocks and bonds.
- Business assets like accounts receivable or invoices.
Including information on the resale value of collateral and data for market demand trends in your application will build the lender’s confidence that they can recoup their losses if you default. It will also make your company stand out as a more professional organization that is on top of their finances and understands business from the lender’s perspective.
Bonus-tip: If the lender does a UCC filing with your assets, make sure they specify which assets by using VIN numbers, addresses, and other identifiers. That way, they can only claim those specific assets vs. taking additional items, which is possible if the UCC filing uses a more general term like “equipment” or “vehicles.”
5. Conditions
Conditions are your plans for using the money, which give more context for the other “C’s,” along with external factors like the market you’re in and potential demand. The future conditions can make past data less relevant, which is why lenders use the past and the future conditions when making a decision.
If the loan is a capital injection to keep the company afloat, lenders will scrutinize capacity and potentially increase their requirements for terms like the debt service coverage ratio to manage future risk.
Meanwhile, investments to expand current operations will make them look more closely at “C’s” like capital to verify you have skin-in-the-game motivation going forward and character to ensure you have the background to successfully manage a larger or more complex organization.
External factors like local or national economic trends might make loans to your industry more or less appealing for the lender, depending on potential audience growth or stagnation. Demographic shifts can alter the makeup of future potential customers, like selling children’s products but population growth is expected to stall. And other loans they’ve issued can make loaning you money risky even with a great application if they have too many loans in your industry.
While you can’t change what other loans they’ve issued, preparing a detailed business plan that shows how your business benefits from economic trends and policy changes, and why your business is unique from others, may boost the lender’s confidence and positive perception of your business.
Bonus-tip: Include a break-even analysis to demonstrate how quickly your business will turn a profit after the new investment.
6. Credit score
Business credit scores give lenders a third-party evaluation of your current debts and how often they’re being paid, so the lender can evaluate the risk of giving you a business loan compared with the other “C’s” of credit. Lenders have different thresholds for scores they’ll lend to, so talk with them about their requirements before applying, since loan applications can cause a short-term hit to your score.
It doesn’t hurt to check your score with major business credit rating bureaus like Dun & Bradstreet, Equifax, or Experian, so you can correct any mistakes before you apply for a small business loan. By getting an updated report before engaging with lenders, you are prepared to explain any red flags they might see in advance. Plus, doing this gives lenders another professionalism green flag, just like being prepared with collateral resale value and data on conditions.
Using the 6 “C’s” of credit as a guide to prepare your business loan application helps you meet the needs of the lender, which may increase your chances of getting approved for a small business loan. The 6 “C’s” of credit show why you are a strong business leader and that your company will be able to make payments on time, reducing your risk as a borrower.