Small business formation is in the spotlight, with 43 states seeing an increase in commercial lending. Commercial loans can be intimidating for first-timers. They are much more intensive than a standard personal loan and are full of terms that many have never heard of before. Understanding what a commercial loan analysis looks at helps you better prepare for your commercial loan application. The easiest place to start is with the five C’s of commercial lending.
1. Character
Lenders want to do business with someone they can trust to repay their loan. An applicant needs to show that they have good character. They can do this in multiple ways. The first is to provide business references. These people can be a testament to your business practices. Other factors considered are pending judgments, a history of fraud, or numerous consumer complaints.
This step in the process can be pretty intense for a commercial loan. For a personal loan, it is just one person that must prove their character. For a commercial loan, the loan officer will want to know the character of everyone involved. This typically means looking at the owners or managing board members.
2. Capacity
The primary focus of the commercial loan analysis is on the borrower’s capacity to repay the loan. Lenders look at current cash flow because this tells them what they can afford. Current cash flow is the most telling because it shows the current business status. However, lenders also consider historical performance and projected growth.
When looking into cash flow, this includes evaluating the borrower’s outstanding debts, ongoing financial obligations, operating costs, and income.
3. Capital
Capital is the amount of money and assets that the borrower brings to the table. In recent years, borrowers have depended heavily on credit to bring their business dreams to life. As a result, lenders want to see that the borrower is invested in the venture. One way of doing this is to “have some skin in the game” by contributing capital. Additionally, a lender may hesitate to extend another loan if a business is already over-leveraged. This analysis is a debt-to-equity ratio. In some instances, an owner or founder could offer a personal guarantee to bolster an application.
4. Collateral
Lenders consider all possible outcomes, including what happens when the business fails. If the business fails, then there is no one to repay the commercial loan. Lenders may require higher-risk borrowers to provide collateral as a part of the loan. High-risk loans could be a particularly high dollar amount or a borrower with a weak application. Collateral is typically a physical asset, such as a building, real estate, vehicle fleet, or inventory.
5. Conditions
The final element of a commercial loan analysis isn’t so much about the lender but the external conditions. The lender may look at the current market conditions to know the competition. If the market is already saturated, the lender may not have confidence in the borrower’s ability to succeed. They will also consider the current financial market and projected interest rates. Finally, the lender will consider the future of the business climate. For example, if the borrower wants to start a business in a dying industry, this won’t bode well for the long-term stability of the company.
Prepare For Your Commercial Loan Application
Knowing what a commercial loan analysis looks at helps a lender better prepare for their application. This helps them build the strongest application possible for the highest chance of loan application approval with favorable terms. Approaching a commercial loan application with the five C’s in mind simplifies the process.
Schedule a consultation with one of our skilled attorneys to discuss your commercial loan plans.
