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Five C’s to Understanding Small Business Credit

Knowing what a lender wants to know when considering a request for business financing may seem like a big mystery. But it’s really not. Lenders just want assurance that potential business borrowers are a safe and smart place to “invest” their loan dollars.

One way to look at this is by becoming familiar with the “Five C’s of Credit” (character, capacity, capital, conditions, and collateral.) This general framework will help you better understand what information is needed to provide a positive outcome to your lending request.

Read on to learn more about the Five C’s and what you need to know about each.

1. Character

Definition: Sometimes called “credit-worthiness,” this “C” refers to your track record for repaying debt as well as your general credibility, experience, and expertise.

Why it’s important: You don’t get a second chance to make a first impression. We know, it’s a cliché, but there’s a reason for that.

The hard truth: This “C” isn’t just about dressing professionally. Lenders want hard data to form an opinion on your ability to pay back the loan. One piece of character data that is scrutinized heavily by lenders but is often overlooked borrowers — Personal credit scores. This is a scary reality for a lot of small business borrowers, since many have little understanding for how important good personal credit is for establishing business credit and may not even know their own score.

Your next move: When it comes to your character, there are several things you can do to present yourself, and your business, in the best light. Stay professional in every interaction. Build relationships. Showcase how your experience or expertise contributes to the success of your business. And most importantly, make sure to keep your business AND your personal business “character” in top form by paying down debt and always paying on time. Keep tabs on your personal credit by requesting a free report from each credit reporting company annually at Consult our list of business resources to see what else you should think about.

2. Capacity

Definition: Capacity looks at your ability to repay a loan. By assessing your debt to income ratio and other factors, lenders can make a judgement as to whether or not you have the “capacity” to meet your loan obligations.

Why it’s important: If you’re unable to demonstrate that you have the ability to pay the loan then your lender will be less likely to offer financing.

The hard truth: It’s all about proving to your lender that you’re not a gamble but a safe and thoughtful investment for their loan dollars.

Your next move: Get your numbers in order so you may demonstrate that you have the means to successfully repay your loan. Understanding and effectively managing your cash flow shows lenders you have the means to make timely loan payments.

3. Capital

Definition: Capital is the amount of money or personal funds an owner invests into the success of the company.

Why it’s important: Lenders want to know you are willing to share financial risk by contributing your own assets to establish the business, prior to asking for funding. A large contribution by the borrower decreases the chance of default and indicates your level of seriousness, which can make lenders more comfortable in extending credit.

The hard truth: According to, investors expect to see a 20-40% of the total loan request come from the borrower.

Your next move: Work with your accountant to determine how much of your own capital is wise to invest to keep your lending request in line.

4. Conditions

Definition: Conditions refers to the purpose for the loan as well as other terms for the loan itself (like loan amount, interest rate, etc.) and takes into consideration how the success of a business could be affected by things outside of its control, like economic and industry factors.

Why it’s important: Lending approval is more likely if you’re able to show that the product or service you’ll offer is viable in your market. Selling surfboards in Rochester? How about bathing suits in Alaska? These are not favorable conditions and are unrealistic toward business success.

The hard truth: Your market must be able to support the plans for your business. That means there must be enough demand to meet your sales projections, and the economy must be strong enough to sustain it.

Your next move: Be sure your business plan is realistic. Be sure to detail how you will use the loan, how it will support your business, and any potential risks. And while you can’t control things like an economic downturn, you can show that you’re prepared to weather unfavorable market conditions. You don’t have to be an economist — but you can be a planner. Look at the economic environment around Rochester to familiarize yourself with the latest indicators.

5. Collateral

Definition: Collateral is additional forms of security a borrower can provide with the agreement that it will be the repayment source in case she cannot repay the loan.

Why it’s important: Lenders will feel more secure in their lending decisions when there are hard assets to secure their investments in the event you default on your loan.

The hard truth: If you’re unable to pay back the loan, a lender will want to have a backup plan as to how they will earn back their investment. The value of collateral is not based on market value; instead, it’s discounted to take into account the value that would be lost if those assets had to be liquidated. See how different forms of collateral are valued by a typical lender and the SBA.

Your next move: There are many forms of collateral used today, including receivables, real estate, inventory, vehicles, cash, and even some types of securities or guarantors who will make good on your loan, even if you can’t. Understand how your collateral stacks up against the amount of your loan request.

Now that we’ve reviewed all five C’s, it’s important to mention that different lenders may weight each “C” differently, based on their own lending policies and preferences. However, when you understand the importance each “C” plays in a lender’s decision to extend credit, you can better prepare your lending request and improve the likelihood your loan application will be approved.