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Do You Know The 5 Cs of Lending?

The concepts that lenders use to gauge the creditworthiness of a potential borrower are called the 5 Cs. If you’re needing to raise money through lenders (banks or investors), you’ll need to understand the Cs and how they affect your chances of receiving a loan.

Capacity

This is you and your business’ ability to make regular payments on the loan. Debt to income (DTI), or debt service coverage ratio (DSCR), are the metrics that are used.

DSCR is calculated by dividing EBITDA (annual debt service) by total debt service (principle plus interest) in a period of time. A DSCR < 1 means that cash must be injected during this period of time to meet debt servicing needs. A DSCR > 1 means that operations are generating sufficient cash to meet debt servicing needs.

Generally, lenders want to see a DSCR of 1.2 within a reasonable amount of time and certainly before the business is cash negative. A debt service of 1.2 means that there is 20% extra cash during that time period than is needed for debt service. It’s common to see climbing gyms with a DSCR < 1 during the first year and moving into and above the needed 1.2 in year two as the membership is increased. Sufficient operating capital is then needed to be available to cover the shortage within that first year.

Capital

This is cash that is invested by the borrower, aka the down payment. Also considered here is cash on hand after the down payment is made (operating capital).

The SBA 504 program allows for a minimum down payment of 10%. Conventional (non-SBA backed loans) generally require 25% to 30% down payment. A large down payment gives banks higher confidence that they can be repaid if the loan goes into default by liquidating the collateral.

Collateral

This is how the loan is secured. In case of default, the lender needs to be able to liquidate (sell) the collateral for repayment of the loan. So, the value of the collateral needs to be at least that of the borrowed amount, and generally needs to be equal to or greater than the total project cost.

Conditions

How your business plans fall within the bigger economic, local and industry picture. Currently, the condition of the climbing facility market would be considered strong! The condition of the national economy would also be considered strong. Interest rates are very low. We are, however, overdue for a recession simply based on the average length of time between recessions. The global economy is showing signs of softening.

Character

That’s you!! It’s defined on paper by you and your team’s experience and education, but it’s heavily displayed by your personality and organization while pitching your venture to lenders. Your business plan, financial plan and model as well as your pitch deck are huge here. Particularly with startups, lenders are in many ways investing in YOU! They want to know that you and your team can execute on the business plan and repay them, plus interest, of course. This is the one C you have full control of!

Fun facts of interest (no pun intended):

A loan under the SBA 504 loan program is actually two loans. The SBA (taxpayers) fund 40% of the loan and a partner bank loans up to 50%. The partner bank can choose to lend less than the full 50%, which results in a larger down payment. However, the SBA allows for a minimum of 10%, which means that often a good showing in the 5 Cs will allow you to negotiate to that 10% down payment.

And keep this in mind: The partner lender gets paid first in a liquidation event, that is, they have a “first position” on the collateral. The SBA (taxpayers) have a “second position”, which means that if there is a shortage during liquidation, the SBA takes a loss, not the bank. The bank simply needs to get 50% of the collateral value to be fully repaid! This is why banks like SBA loans – their risk is lower than a conventional loan that would have an LTV (loan to value) of 70%, and a bank would need to get 70% of the value of the collateral. At the same time, the borrower needs to come up with just 10% down rather than 30% down for a conventional. Make sure to thank your fellow taxpayer for taking a risk and supporting entrepreneurism!

Want to learn more about the lending process?

Click the link to check out my PowerPoint presentation from the 2017 Annual CWA Summit:  CWA Summit Financing Presentation. In it, even more information about the lending process is unveiled – all for FREE and for your use!

Want even more?

Sign up for our Business Development Package and you’ll get a load of valuable documents and tools that you and I will customize for your project. Plus, you’ll get general development consultation directly from me!

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