Dear M & M:
What do I need to do to obtain capital or get a loan for my business? What are some things I should be thinking about?
There are many things to consider, but keep in mind it is all about lowering the risk to the lender, whether it is a private investor or a bank. Here are three “C”s to keep in mind (Character, Capacity, and Collateral). The first “C” is your Character. This is your past performance. What is your track record in paying on time?
Know what your credit score is. A credit score above 700 is the benchmark many lenders use to gauge your creditworthiness. Anything above 700 lowers the banks risk, as it shows you have a past history of paying your obligations on time, thus lowering the bank or lenders risk of default. It shows you are likely to pay your obligations.
Remember, if a lender isn’t concerned with credit scores they are looking at the report and seeing who and what you are behind on. For instance if they see you are behind on child support payments they are thinking what are the chances they will pay me back if they get into trouble if they can’t even fulfill a family obligation?
The second “C” to consider is Capacity. What is the ability of your business to pay back the loan? Once again the more viable or profitable your business is the lower the risk, and the probability of your business to pay back the loan increases proportionally.
This is where debt to income ratio is looked at. Do you have enough income to take on more debt? Does this new business or piece of equipment increase the cash flow? Does it generate enough cash to pay me back? The last “C” is Collateral (this is the lenders plan B).
If for some reason you can’t make the payments on the loan the bank has an asset that they can take to settle the debt or to get the money back. The more liquid the assets you can put up as collateral and the larger the value of your collateral, the lower the banks risk in case of default. It is not uncommon for a bank in today’s environment to want a 20-30% cash commitment from the borrower.
The value of your collateral will be looked at. Remember the lender is giving you cash. They want to be repaid in cash in monthly installments. They really don’t want your house, your car or other forms of collateral. They want to be repaid in cash. They will allow other forms of collateral to be put up to settle your obligation, but it is unusually discounted.
They might have to pay someone to sell your collateral at a discounted price to settle the obligation or the loan. Many times a fourth “C” called conditions is also considered. This could be anything from market conditions to environmental considerations.
In addition, to the 3 or 4 “C”s it is important to have a plan well laid out, showing the use of the funds, and how you plan to pay back the loan request. Keep in mind anything you can do to lower the lenders risk increases the likelihood of having your loan request for additional funds being accepted.
Remember lenders do want to make loans they just want to be certain they will get their money with interest back.