A great business plan can get your foot in the door, but it will rarely get you a loan. As America struggles through one of the worst recessions in history, lenders are facing tighter restrictions, which means they're increasingly cautious about which businesses they're lending to. Good credit has always been an important facet of the overall health of your business, but experts agree that now is the time to beef up more than just your credit score and take a deep look at how you can improve your business in the eyes of lenders.
"The thing that's hitting us right now is the conditions of the marketplace," says Denise Beeson, a commercial loan officer with Bay Sierra Financial based in Santa Rosa, California. Beeson explains that banks are sitting on very toxic portfolios, and the only firms that are receiving funding are high-end sterling borrowers; in other words, businesses that exhibit a proven history of repaying their loans and posting profits.
Building and Maintaining Good Business Credit: Why It's Important
Good business credit provides access to capital, which is more important than ever, says Jeff Allen, a partner at Trendant, a small business consulting firm based in Utah. "What we've seen with a lot of small business owners is that they have really good months and they'll have an influx of orders, and they'll be able to fulfill them, but the next month or the month after that, they're back down to what they were," meaning that the orders stop flowing and the businesses need cash to sustain their operating costs. It's not uncommon that small businesses face this kind of down time, Allen says, and with good credit small businesses can weather these types of marketplace uncertainties.
Building and Maintaining Good Business Credit: The 5 C's of Good Credit
The crucial elements of borrowing money from a bank can be grouped into five categories known as the "Five C's," which is the ultimate credit checklist for any entrepreneur or small business owner.
"The five C's are very important," says John Seelinger, a California-based volunteer at SCORE, a non-profit organization dedicated to assisting entrepreneurs and small business onwenrs. "You can't afford to be sloppy or haphazard with them. The underwriting process may be different, but the fundamental five C's are always there," he says.
Capacity refers to your ability – as a business – to repay the debt to the bank in a timely fashion. More than anything, a bank will look at your businesses' financial history to determine whether or not they will grant you a loan, so it's important to make sure that your company history has a pristine repayment record.
"Historicals is really important," says Allen. "Everyone comes up with projections, but actual historical information that can be verified is one of the most important things you can have. Without your historical information to back up your ability, you just have a 'plan.'" The bank will also assess how much debt you can really handle, and if the loan you're requesting makes sense given your cash flow.
Dig Deeper: The Personal Guarantee
Banks want to be sure that they are lending money to reputable and trustworthy businesses. They're also looking to see that you're an expert in the industry your business operates in. Your character – both as a principle of the firm and the reputation of the business itself – should not be underestimated when approaching a bank for funding.
"You may see this as kind of inconsequential, but the quality of your references and the background and experience that you have to bring is critical," says Beeson. Plenty of people who have a great portfolio get turned down for a loan because they do not have any personal experience in that business.
Banks will also look at your personal credit, so maintaining a strong personal credit score is imperative. "A lot of what people do in their personal life goes directly into what they do in their business life," says Allen. "If they have a history of running up credit cards on a personal level, they'll probably fall into the same habit in a business." Remember, a bank will take a 360 view of your personal financial history, so before applying for a loan make sure you've settled any personal debts that could negatively affect a chance to obtain a loan for your business.
Dig Deeper: How to Secure an SBA Loan
If you haven't invested in your business, why should a bank? A bank will scrutinize the financial investments that you and your co-founders have made because it's a good indication of your vested interest in the venture.
"Often times a small business owner who is just starting out will go to a bank and ask for a small business loan, says Beeson. "The bank is not going to lend them any money if they have no personal investment in their business." Essentially, banks want to see a track record that shows your dedication to your business, and a history of success within that field.
Dig Deeper: How Do You Raise Money for a New Business in Tough Times?
Historically, collateral is the most important criterium in order to obtain a loan and establish a good credit line. "The key is collateral," says Allen. Collateral can be anything from real estate to equipment, and even purchase orders. If a business has an order that comes in, Allen says, "a bank will lend on that all day and night, because that's an order you can fulfill and then pay back."
Used equipment, an old truck, and other unsubstantial items that would not generate any substantial money for the bank are not going to be considered by the bank. "They're going to want to look for real property, and often times it's your home that they look for," says Beeson. "And with the real estate market as soft as it is, much of that real estate collateral is gone in equity. Unless there is a 401(k) plan or a stock portfolio or some collateral assets that are real, the bank isn't going to fund you."
Dig Deeper: How to Fill Out a Loan Application
The bank will want to know what you will be using the money for, and what the current trends within your industry are. Beeson says that it's important to recognize that certain banks prefer to offer loans to certain industries, and so it's smart to target the banks that are most likely to view your loan favorably.
"I always tell people go to three banks like you would find a doctor," Beeson says. "Find a bank that wants to work with you and find out what it is you need to do. Prepare yourself for their criteria for a loan; it's not one size fits all." Overall, banks can be very choosy as to what their portfolio of loans looks like, so do your homework and find the best bank to suit your business's purposes.
Dig Deeper: How to Use a Personal Asset Loan for Your Business
Building and Maintaining Good Business Credit: Resources to Improve Your Credit
The first thing you can do to improve your credit is to make sure that all credit ranking companies, like Dun and Bradstreet, have the correct information about your firm. A wrong company name or a repaid debt that is not accounted for can ruin your chance of securing funding. Rectify any administrative mistakes before approaching a bank.
And, if you're having trouble securing a loan, or if you've been denied funding altogether, Beeson advises that you consider non-traditional financing routes, like peer-to-peer lending. Sites like Prosper and Kiva connect people who want to invest money with people who want to borrow money. And though you're not going to be able to finance a multi-million dollar business through these arrangements, they can get your business back on track.