With the American economy limping along, a great deal of attention has been focused recently on the availability of credit. Borrowers complain that bankers aren’t making loans, and bankers complain that their willingness and ability to make loans are hurt by regulators’ cautionary statements and guidance. Facts and figures are used to support the various positions, but the most pressing issue on everyone’s mind is: What does a borrower need to do these days to get a loan?
Nearly 600 years ago, a borrower faced a somewhat similar question. Christopher Columbus visited several sovereigns seeking backing for his proposed voyage before finally focusing on the king and queen of Spain. He was granted his first audience with Queen Isabella on May 1, 1486, and it was there that he presented his plan to find a route to Asia.
How did that meeting go? Well, he didn’t get his financing. Following that meeting, he would have several other meetings with the monarchs, but then, as now, the lender was facing uncertain economic and political times, and he had to refine his plan and earn the monarchs’ trust.
A few years later — six to be exact — he finally obtained the financial backing to undertake the voyage that led him to discover America. What happened during those six years? The economic and political climate had improved, giving the lenders more comfort to act, and Columbus had sharpened his proposal and impressed the monarchs with his persistence.
Identify a Lender
Columbus’s story demonstrates that the business of borrowing money really hasn’t changed much in half a millennium. Today, in many ways, borrowers face the same situation as Columbus did.
Just like Columbus, today’s borrower first needs to identify a lender who has the capacity, knowledge and interest to work with him and his business. Fortunately, the American financial services marketplace is very broad, and there are lenders and lending programs at all borrowing levels.
For example, if the borrower has a specialized business, there may be specialized lenders willing to provide financing. A small borrower may qualify for a loan that is backed by the Small Business Administration but is issued by a large commercial bank. The bottom line is that the first decision that a borrower has to make is where to seek financing. In answering that question, a borrower must be able to clearly articulate his needs.
Sailing the C’s
Having assessed their needs, borrowers then need to focus on the information that lenders are looking for today. Any loan officer will tell you that the fundamentals of obtaining credit revolve around meeting the five “C’s” of credit. Those are generally known as: conditions, capacity, capital, collateral and character.
- Conditions. This term refers to the fact that a borrower must be able to describe his business and show where it fits in the economy. He also needs to show an understanding of how current economic conditions affect his business, his industry and his particular market. To best meet this C, borrowers should have a business plan and be able to describe how they’ve followed the plan and how the financing they seek fits into it.
- Capacity. Capacity simply means that a borrower must show that his business can generate enough cash to repay the debt. A borrower needs to convince the lender that there is adequate cash flow to repay the loan and to pay for all other business expenses as well as his own personal needs. Financial statements and tax returns are needed here.
- Capital. This term refers to the business’s staying power and whether the owners have “skin in the game.” If a company has capital, it shows it has earnings that it can retain, fixed assets and equity. Capital shows that the company has the ability to survive tough times, and in order to demonstrate that he has adequate capital, a borrower needs to have a balance sheet.
- Collateral. No surprise here. This term refers to the means by which the lender will be repaid if cash fails. It always will be some or all of the borrower’s assets and will usually involve the guaranty of the company’s owners. In some cases, that guaranty will need to be backed by a lien on the guarantor’s home or other assets. To be effective, a loan request should include a listing of the collateral that the borrower is willing to offer.
Unsecured credit is available, but generally it is only granted to the strongest of borrowers (those with an abundance of capacity) and those known to the lender. If a business seeks unsecured credit, it must be prepared to demonstrate that its capacity for repayment is very strong.
- Character. This last “C” is somewhat subjective, but since a loan is nothing more than a promise to pay money, this consideration involves an assessment of the likelihood that a borrower will make good on that promise. To test this, lenders will ask about the borrower’s credit and that of the business.
Lenders will investigate a borrower’s reputation in the trade and markets generally. They will want to know who is on the borrower’s team: accountant, lawyer, insurance and other professionals and consultants. Lenders will examine whether the business records are in order and will ask whether there are any outstanding judgments. Importantly, they will want assurances that the borrower and its owners have paid all their taxes and have current licenses.
Tell the Truth
Borrowers must be able to address these items because they paint a picture of the borrower and its business. A positive spin about the borrower’s story and prospects may be all that is needed to put a lender’s concerns in their proper context. But above all else, the borrower should be prepared to tell the truth; it speaks volumes about character, and it’s the law when seeking a loan.
The regulators have weighed in on the issue of credit availability in that they have issued guidance to lenders reminding them that the regulators want the lenders to be in the marketplace looking for qualified lending opportunities. With that direction from the government, meeting the five C’s is more important ever.
Identifying potential lenders is not difficult; the time-consuming part of the process comes in trying to narrow the list of potential lenders to the list of candidates to actually contact. That process can take some time, but it can be made easier with the assistance of knowledgeable advisers and referrals.
The initial meeting with a lender is the beginning of a process. Borrowers should be prepared to engage in a dialogue with the proposed lender and get to know it, its capabilities and its experience in the borrower’s business.
Remember, Columbus went to various lenders and it took him six years to get financing from the one he chose. One thing is certain, even in this age of instant communication: Potential borrowers will still need to prepare just as hard as Columbus did to convince a lender to grant a loan. But for borrowers who prepare and meet the five C’s, it won’t take them six years to get approved.
For more information, contact the Davis, Agnor, Rapaport & Skalny attorney with whom you typically work, or one in our Business Planning & Transactions Practice Group.
