By Candi Pavliscak
August 19, 2010
It’s back to basics for companies seeking commercial credit, or intending to do so, as economic markets slowly recover and restrictions on commercial lending ease, albeit slowly. One of the foundations of commercial lending from the lender’s perspective is the longstanding abbreviated 5Cs of Credit: Character, Capacity, Capital, Conditions and Collateral.
Perhaps you haven’t given much thought to the 5Cs since college finance 101. For new or would-be business owners who entered the entrepreneurial world without a traditional business degree and have yet to embark on the formal process for obtaining commercial credit, the 5Cs may be a new concept altogether.
Whether an introduction or a refresher, the 5Cs of Character, Capacity, Capital, Conditions and Collateral are the factors used by lenders to evaluate potential borrowers. If your business is currently receiving financing or will be seeking financing in anticipation of a new or pent up demand for your company’s goods or services, it is helpful to know the key indicators that lenders consider to start or continue a lending relationship. Moreover, the 5Cs can be applied by businesses to evaluate prospective supplier relationships as well.
Character
Character is the overall impression you and your executive team make on your lender. Background, experience and reputation all play a part in the assessment of character. Lenders want to know they are dealing with individuals who are forthright and honest and will work with them rather than against them in difficult situations. The components of character should apply to one’s suppliers as well.
Capacity
Capacity is the ability to repay loans. Capacity is the most critical metric lenders evaluate -- and it should be just as critical for the borrower. A lender wants to ensure before one dollar is loaned, that the borrower can pay it back. Do you know if your supplier has the ability to pay its suppliers? Payment history with other vendors and securing credit references helps businesses assess this factor.
Capital
Capital, in this sense, describes an owner or management teams’ personal investment in the business. Lenders prefer business owners invest personal assets and assume personal risk before seeking financing. Lenders want to see that the entrepreneur has a vested interest and is positioned to lose something of value should the business fail; they want owners to “have skin in the game” in connection with their loan. The application to suppliers is to confirm they have buy-in to ensure that quality products and services can be delivered according to previously agreed upon directives, and that failure to do so can have an adverse impact on their business as well.
Conditions
Conditions refer to current economic conditions as well as the competitive landscape of the business seeking capital. Equally important, it describes the purpose for the loan and defines what the money will be used for. Would-be borrowers need to be able to articulate the value of their product and assess the position of the competition to lenders. It is also a good idea to assess and explain how the company will handle growth in strong economic times and weather the storm in a downturn. Can your suppliers offer a plan to provide you with needed goods and services in a variety of economic conditions?
Collateral
This is what you own and can pledge as security for a loan. Lenders want to see what assets can support repayment. While cash is always the primary source of repayment for a loan, pledged assets offer a secondary source. Is your supplier base strong and well run? Does your business have a backup plan if your key suppliers exit the marketplace?
While the 5Cs of Credit are a cornerstone of lending philosophy, they can also be used by anyone else evaluating your business and its needs for the future. In addition, you can apply these key principles to more than just your lending relationships, you can use them to evaluate the strength of your suppliers as well.
Candi Pavliscak is senior vice president of Hennessey Capital LLC, a Michigan-based specialty finance company providing working capital to small and mid-sized businesses. She can be reached at cpavliscak@hennesseycapital.com.