How to Apply For a Loan : The Four Cs

Lenders are looking for the ability of a company to repay its debt. No matter how successful a company is , usually a lender has only the promise of being rewarded with steady payments of principal and interest. While a borrower may become a better customer of the bank as the business grow s, the bank will not necessarily proposer in direct proportion to the company’s success. When lenders consider a loan request, they concentrate on what are sometimes referred to as the “Four Cs” of credit: Character, Cash flow, Collateral, and (Equity) contribution. Let’s look at each of the four Cs in turn.

Character:

Character is a crucial element in an entrepreneur’s attempt to secure loan. “Character” is, of course, a subjective, “soft” criterion that enters into the lender’s decision-making process. Nonetheless, lenders mush has confidence in the individual they are dealing with or they will not proceed with the venture. Such traits as talent, reliability, and honesty are used to describe character.

One aspect of character that lenders consider is entrepreneur’s credit history. Credit history in terms of a commercial loan is a one way street. A bad credit rating will often eliminate the potential for a new business to obtain credit. A good credit history, on the other hand, has little upside.

In the final analysis, even with a positive credit history, a banker’s decision comes down to intuition: How capable is this individual? Will he or she run the business ethically and keep the bank honestly appraised of the real status of the business? How much faith does the bank have that this individual can successfully run a business and pay the monthly debt service?

Cash Flow:

Banks need to be satisfied the cash flow will be adequate to cover debt service throughout the term of the obligation. Most loans are structured with interest payments due every month, beginning in the first month, and principal payments also due, usually beginning in the first month. In some instances, principal payments can b deferred, but usually no more than a year.

The business must be solid in order to meet debt service and operating obligations and yet still have enough cash available to address uncertainties. The entrepreneur must remember that projections are imperfect and must therefore provide for deviations. Lenders will want to be assured that the margin for error has been considered and provide for amply.

Collateral:

No good lender will make a decision to loan money based solely on strong collateral. But every good lender will try to get the best collateral possible on the loan. This normally involves securing the lender’s interest by liens or mortgages against tangible assets such as real estate or equipment. In addition, most lenders will require the entrepreneur’s personal signature as evidence of the borrower’s real commitment to the business.

Contribution:

Almost all lenders require a significant financial contribution by the government to ensure the success of the financing. It also serves to reduce the lender’s exposure relative to the deal’s total size. This provides a cushion allow the lender to come out “whole” in the event of default.

In addition, different industries customarily have different rations of debt to equity, commonly known as leverage. Some industries have rationally been highly leveraged with debt three to four times greater than equity, often because of high success rates and good collateral. Real estates and the apparel industries are good examples of highly leveraged businesses. An unusually high failure rate or poor-quality collateral may result in relatively low leverage in an industry, as exemplified by the restaurant business. Because of these varieties, it is difficult to generalize as to how much the entrepreneur must contribute to a venture.