While I’m sure everyone around me enjoys how I can drone on and on about technical minutia that affects repayment, I can appreciate there is great value in being concise. I had a regional manager in Washington DC, who provided the most concise explanation I have ever heard on how anybody off the street can assess their likelihood of qualifying for a business loan.
My manager started from the obvious touchstone of the 5 Cs of credit. Except, he explained them in a way people outside the industry could easily grasp. The 5 Cs of credit are Character, Capital, Capacity, Collateral and Conditions.
1) Lenders look at your Character, which means, can you be trusted based on your background and experience? Do you have a history of paying loans back? Are you qualified to be doing what you are doing?
2) Next, lenders look at Capital. Lenders want to know you have something personally invested in this too. Do you have money saved that you can contribute? Do you have resources to fall back on in hard times?
3) Lenders will examine your Capacity to repay the loan. How profitable will your business need to be to repay the loan? Is your idea feasible?
4) Lenders need Collateral. Is there something of value that can always be sold to repay the loan? If the loan goes into default, will you sell something to make the lender whole?
5) Lenders always pay attention to Conditions. Is there demand for the product or service? Is the industry on its way up or on the way down?
On a scale of 1 to 100, you can assign a score to each of those five things. A 1 means the category is weak or there is simply nothing there, and a 100 means the category is unquestionably strong.
Then, you can assume that each category contributes to roughly 20% of the decision on whether or not you will get the loan. You can apply your 1 to 100 rating for each category, and multiply each category by 20%. Then add up the results from all categories, and you will have a percentage that reflects the overall chance you will get the loan!
Just for example, say you had a business idea you wanted to borrow money for, and you assigned Character 80, Capital 50, Capacity 75, Collateral 50 and Conditions 90. Now we can work through the simple calculation.
Character : 80 X 20% = 16% ; Capital: 50 X 20% = 10% ; Capacity: 75 X 20% = 15%; Collateral: 50 X 20% = 10% ; Conditions : 90 X 20% = 18%
Then we have 16% + 10% + 15% +10% +18% = 69% chance of gaining approval. And you can even clearly see what areas need to improve if you want to increase your chances! While this isn’t the assessment that will be done by the lender, it is a very helpful tool for the borrower to consider before approaching a lender with an idea.