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The 5 C’s of credit for starting a small business – Hendersonville Standard

“Hey, um…they told me to give you a call. I have a great idea for a business and they said that you were the man!”

I know I’m in trouble when I hear this. And I never really find out who “they” are either.

By the way, this dude’s name was Xander, but he was my age.

I didn’t go to school with any kids named Xander back in the 80’s and 90’s. All the boys were named Jason, Jeremy, and James…and anything else with a J. But not Xander, and especially Xander with an X instead of a Z.

“Yes sir, I have talked to at least three other people and they all redirected me to you. You see, I have all the ingredients for a cake, but I just need the recipe if you know what I mean, so when can we meet? Today?” Xander said.

Xander was extra proud of his analogy since his business idea was a cupcake shop that targeted men. You know, cupcakes with bacon, buffalo chicken, and beer.

“Nobody else is doing this. I just need the recipe which in this case is the business plan so I can get some money.”

After a quick discussion about how a business plan doesn’t get a loan, we talked about all of his ingredients or rather his ideas.

It didn’t take long to discover Xander was missing the main ingredients ie. capital, collateral, and cash flow.

I explained that this was like missing flour, sugar, and eggs for his cupcakes.

He was deflated and even a little indignant.

“How could banks be so shortsighted?” Xander asked.

Didn’t they know this was a goldmine waiting to happen?

I suggested starting this goldmine on the side and building it up to get a proof of concept going, as well as, obtaining some of his own capital.

He didn’t seem very interested in that at all.

“Well, thanks I anyways…I guess.”, Xander said as if I just told him he wasn’t allowed to start at all.

Meanwhile I have helped several startups get funding, but they had more of the ingre…ugh, I’m already sick of that analogy; they had their 5 C’s of credit lined up first.

A big difference was that most of the startups had begun as a business on the side while they held down full-time jobs, which was difficult, but gave them a proof of concept first.

For example, there was the fitness trainer, Jennifer (there’s that hard-working J name that I was looking for) that built her business on the side while she held down a full-time job.

Once she had enough clients to justify going out on her own, she quit her job and added even more clients.

Jennifer did group coaching classes and one-on-one coaching sessions.

Her goal was to have her own fitness facility because right now this was all happening in the park, in her garage, and at her clients’ homes.

Jennifer found a place that was just right for her business. It was close to her core group of clients and she could make the numbers work.

She wanted to get a loan to do some buildout (light construction in this case to turn this leased property into more of a fitness facility), buy some specific fitness equipment, and have some working capital leftover.

Her estimated startup would be $100,000.

Below are what banks refer to as the 5 C’s of Credit that determine if you get funded.

Capital — Banks want you to have at least 20% of your own cash when you start. But why do they make you have money to borrow money? To show that you have at least some ability to manage your own money and so you will have some skin in the game.

So that means that Jennifer needed to have at least $20,000 of her own cash. And as luck and hard work would have it, she had saved $20,000 while doing this for the last two years.

Collateral — This is the fixed asset that you can use to secure the loan. This is what the bank can get from you in case you stop paying them. They like houses. They don’t like cars, jet skis, or your baseball card collection. They like fixed assets that appreciate.

Jennifer and her husband had owned their home for a while and had a little bit of equity, so they used it for collateral. She also pledged her fitness equipment, but it wasn’t enough on its own to hold the note.

Cash Flow — This is your ability to repay the loan based on both the business and your personal financial situation. The bank wants to make sure there is more cash coming in than debt payments going out; usually they like to see that you have 25% more net income than you do debt payments going out.

In most cases, the bank will not count your business income until your business has been around for two years.

Jennifer had both her business income and her husband’s income to count toward the loan and they didn’t have much debt other than their home, so she was in good shape.

Conditions — How are you spending the money from the loan and what are the current economic conditions and industry trends.

Jennifer was able to show that she needed $25k for buildout, $35k for equipment, $25k for working capital, and $15k for additional startup costs (deposits, marketing, etc.)

Character (Credit) — Do you have at least two years of experience in this industry, have some type of managing experience, and is your credit good? Essentially, are you a good bet?

Jennifer had shown a willingness to build on her own, had a lot of experience, and a credit score of 720+.

In spite of a pandemic, Jennifer’s business is growing.

Not because she was able to get a loan, but because she was already in the position to get the loan by doing the right things right.

I haven’t kept up with Xander, but I would like to try an IPA cupcake one day.

Charles Alexander is the director of the Small Business Development Center at Vol State.