Can you measure your 5 Cs?
One of the many mysteries of business funding is whether, or when, a bank will lend you the money needed to launch or grow. In other words, are you bankable? Turns out bankers will measure your 5 Cs to answer that question.
Below, we have a link to a free tool from the most entrepreneur-centered college on the planet – Babson – to help you figure out the answer.
What Are the 5 Cs of Banking?
Banks each have their own slightly different underwriting process – that is, how they decide whether to lend money, and how much, on what terms. But for a long time banks have used the 5 Cs framework as a simple way to describe their underwriting process to businesses looking for loans.
The 5 Cs of bank loans are:
- Character (including Credit score)
- Capital (to measure Commitment)
And yes, there are sort of 7 Cs in the 5 Cs here!
Here’s the link to Babson’s tool to measure your 5 Cs. We have a quick summary below of the Five Cs of bank loans but this online tool has lots more detail.
The diagnostic tool asks questions about these squishy concepts so you can start to measure your own business’ credit worthiness in the eyes of a bank, as well as for other sources of debt financing.
At the end of the process it will show you which sources of debt could be a fit for you now!
Character including Credit score
The first “C” refers to the borrower’s personal qualities, including the measurement by the credit industry known as the personal credit score or FICO score. Other factors include:
- Employment history
- Management abilities
- Working relationship with others
- Personal and credit references
- Personal and business reputation
- Level of education
Banks look at how much cash (and other assets) you have already invested in the business. If you have “skin in the game” it means you have more Commitment (yup, that’s another C) to making the business a success. And, more Commitment to paying back the bank’s loan!
If you can invest even more Capital in the future, that also increases the chance the bank’s loan will be repaid. It also improves your debt-to-equity ratio, which banks like.
Banks look hard at business cash flow, and sometimes personal cash flow, to figure out if the loan can be repaid. The technical name for this Capacity to repay a loan is Debt Service Coverage Ratio. How much of the business (and/or personal) cash flow can be used for loan repayment versus other things?
Banks don’t want your debt repayments to be a burden you can’t manage.
In many cases banks want a claim on business assets just in case a business defaults on a loan. So they look at assets that could be used as collateral and judge how valuable they would be if the bank had to get ugly and seize them because a business isn’t paying back its loan.
They very often will also look at personal assets, and insist on a personal guarantee that puts a business owner’s house, and car, and savings on the line.
Part one of Conditions is how a loan will be used within a business, and generally the condition of a business. Is it a well established business with a well established customer who pays slowly, and that’s why the loan is needed? Or is it a brand new business with an untested product or service? Banks and their regulators are conservative for a bunch of reasons (remember the Great Recession when not-so-conservative banks went bankrupt?). They shy away from things that have risky Conditions.
Part two of Conditions is economic strength, of the national and local economy in general and your industry in particular.
Navigating the Five Cs
First, use the Babson Five Cs Diagnostic Tool to get an initial measurement of how likely your business is to be able to get approval for a bank loan.
Then, armed with that knowledge, go talk to your banker. Remember: not all bankers operate the same way. But now you will be able to understand in general how they figure out if you qualify for a bank loan, for how much and on what terms.
And remember that when you get the answer from this tool, it’s focused on what debt “Funding Sources” might be a fit for you. Bootstrapping, grants and equity are another matter altogether and your 5 Cs measurement won’t give you the answer of whether you can get different colors of funding. But this is a great start!