How Banks Make Lending Decisions
A lender wants to be assured that your company can and will repay the loan as agreed, and that the loan will not saddle you with too much debt, which could cause financial problems for you. To get this assurance, the lender will evaluate your business plan to learn about you, your associates, your objectives, and your plans for the company.
The lender will be looking for the Five Cs of credit:
Capital - How much of your own money do you have invested in the business? How much money do you have in reserve, in case of unexpected needs?
Collateral - What is the fair market value of the security that you are offering to guarantee repayment of the loan? Does it meet the classic criteria for good collateral: (a) ease of transfer of title, (b) low cost/no cost to maintain/service, (c) increasing in value, (d) a ready and liquid market.
Capacity to Repay - How much profit will your company generate? Will your cash flow provide you with enough money on a regular basis to cover the repayment of the loan? Are your projections for sales and profits realistic when compared to other firms in the same industry?
Conditions - What are the economic, demographic, and regulatory trends which impact your business? What terms can be negotiated to allow the bank to evaluate the risk/reward considerations?
Character - What is your track record, personal and professional, in managing finances and paying credit obligations? Who are the key managers in your business; do they have the experience and the ability to run this business successfully?
HOW WILL LENDERS EVALUATE YOUR PROPOSAL?
Lenders have rules and policies to follow in determining the risk and feasibility of your plan and evaluating your loan proposal. In addition to business and financial projections a lender will look for six important factors:
Equity - The lender expects the
borrower(s) to have already invested from 10 to 30 percent of the loan amount. If your business has existed for less than three years, plan for 30 percent.
Collateral - Lenders require sufficient collateral to protect the loan. The items pledged to secure the loans are assets which reflect the following liquidity:
Certificate of deposit 100%
Real estate 75-80%
Stock (publicly traded) 75%
Accounts receivable 50-75%
Personal guarantees - All parties to the loan request must be willing to pledge guarantees. Personal guarantees state that the
borrower(s) truly believe in their venture.
Good credit based on borrower's credit
Ability to carry debt service - The cash flow projections normally reflect this.
A secondary source of repayment - Important especially in start-up venture (e.g., spouse has a full time position)