The 5 Cs of Qualifying for an SBA Business Loan

If you plan to start or expand a business, chances are you’ll need to seek funding. In a 2015 study by Bank of America, 24 percent of entrepreneurs indicated they intended to seek a business loan within the coming year. Many of those would apply for an SBA loan through an approved lender. But what is the current climate for SBA lending?

“Bipolar,” says Ami Kassar, CEO of MultiFunding, a company that helps businesses find financing. “If you’ve got great credit, cash flow and collateral, lenders will jump to give you a great loan at an awesome interest rate. If you don’t, they’ll jump to give you a loan at crazy interest rates that aren’t affordable. It’s like the wild, wild West out there.”

He is referring to three elements of a group commonly known as the 5 Cs: five factors that banks analyze to determine whether to approve your small-business loan application. Guidant Financial is one company that works with entrepreneurs on those 5 Cs every day to help them obtain an SBA loan. Here’s a look at the factors Guidant has found to be important to banks, particularly when it comes to SBA loan qualifiers.

1. Capital

Also referred to in the industry as equity injection, capital is your skin in the game in the lending transaction. No bank will fund your business at 100 percent of your total cash needs. If you’re creating a new business, typically the bank will require you to contribute 30 percent. If you’re acquiring an existing business, expect your contribution to be 20 percent.

Capital is a deal-breaker for banks. Most advisors will tell you not to proceed with preparing a loan application if you cannot provide the required contribution.

If you don’t have the capital, your goal becomes to figure out how to raise it: find a business partner, use a rollover for business startup arrangement or cash out an investment. Note that you may not use borrowed money as an equity injection. Don’t, for example, go looking for a home equity line of credit as your capital investment. If a bank discovers that your capital contribution is subject to debt service, it will likely deny your loan.

2. Credit

Credit comprises your personal credit score, your credit history and an analysis of your credit utilization. A new trend in SBA lending is that banks may also use the FICO Small Business Scoring Service to assess your credit risk. If you can’t meet the minimum scores (which vary among lenders), you’ll need to step back and take the time to improve your credit score and your credit presence.

It’s better to do your homework upfront. You can receive one free credit report per year from each of the big three credit reporting agencies (Experian, TransUnion or Equifax). Check each for accuracy and consistency, and take care of any issues that might be a red flag for the bank.

3. Capacity

Capacity, or cash flow, represents your ability to generate income that will pay your debts. If you’re starting a new business, the bank assesses your global cash flow — your current personal income as well as your projected income from the business. If you’re acquiring an existing company, the lender wants to see that the last three years of business tax returns reflect positive cash flow and profit.

The bank won’t give you money if it sees no evidence that you can repay it. Your capacity is an important part of the evaluation process for the loan. If you don’t have sufficient capacity, consider bringing on a partner to add cash flow to the scenario.

4. Character

Character isn’t a question of your personal charm — it’s your business character the bank will assess. What’s your business experience in general, and in the industry in which your new business will operate? Have you managed profits and losses successfully in your previous business or for an employer? Have you worked your way up through an industry and gained experience in multiple aspects of its operations?

Your SBA loan application should draw from the same work you do when preparing your business plan — mapping your experience to the skills necessary to run your business.

The SBA does care about some aspects of your personal history as well. Would-be borrowers are often surprised to learn that they must provide information on any current criminal charges they are subject to, any recent arrests on charges, any convictions or guilty pleas in their history, and, if they’re at least a 50 percent owner in the applicant business, whether they’re delinquent on child support.

5. Collateral

Entrepreneurs can also be badly caught off guard by the SBA’s stance on collateral. The SBA expects its loans to be fully secured, but it won’t generally decline a loan based on inadequate collateral, assuming the borrower satisfies the other four standards. However, if you have what the SBA terms “worthwhile assets,” the lending bank will require they be used as security for the loan.

In particular, if you own a home with a value of greater than 20 percent equity, the bank will take a lien against your home as security for the business loan, whereas if you don’t own a home and meet all other loan criteria, the bank will likely approve your loan unsecured. It can be unpleasant for entrepreneurs with a more solid financial base to discover that they’re required to take on more personal risk than some of their peers.

This can particularly bring business partners into conflict with each other if one has a qualifying equity stake in a home and the other doesn’t, since the home-owning partner will be required to assume this risk to proceed with the loan application.

What are non-negotiable qualifications to obtain an SBA loan? Banks are currently looking for personal credit ratings in the high 600s and up. Recent bankruptcies or no evidence of cash flow are also generally deal-breakers.

Entrepreneurs should remember every bank or lender interprets the SBA regulations a little differently. If you’re turned down by one lender but believe you have a strong business case, keep searching.

As always, consult a financial professional before entering the application process. Experts can save you time and frustration by helping you understand (and, if necessary, improve) your position. Guidant counsels entrepreneurs to have their accounting in order and then make sure they’re aligning themselves with the right partners who want to help them succeed — and who aren’t sticking them in a trap of unfavorable loans with interest rates that can cripple their business right out of the gate.

The 5 Cs aren’t just barriers to overcome. They are the path to bankability. When the 5 Cs align for the bank, there’s a much better chance they’ll align for the success of your business as well. You can find out more about SBA loan programs at the SBA website.


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