Equipment financing lenders, as well as banks, use the Five
Cs to evaluate loan applications: Character, Credit, Cash Flow, Capacity and Collateral.
However, while banks look at small-to-medium size companies from a Fortune 500
perspective, equipment financing companies see applicants from a small business
perspective, which highlights a sixth C: Common Sense.
Here is what a lending institution means when referring to the Five Cs:
CHARACTER - Every lender wants to understand what type of borrower an applicant
will be in order to make smart, safe credit-granting decisions. The longer a
company has been in operation, the more its payment history and outstanding
credit reveal management’s attitude toward debt and making timely payments.
Public records and references can come into play; still, the most reliable
yardstick is the character of a smaller company’s owners. How they manage their
personal financial obligations is usually a reliable indicator of the
likelihood of their making timely payments. The more closely held a company,
the more attention given the personal credit history of those in charge and
their prior business history. No matter how solid a business plan appears and
how reliable a company’s owners have been in the past, the realistic lender
also wants the assurance of personal guarantees from the company’s owners. This
may take the form of a signature or a pledge of cash or other collateral.
CREDIT - Business credit reports offer a quick glance at a company’s
willingness to pay trade accounts on time, as well as any derogatory public
records, such as suits, liens, or judgments that negatively affect a company’s
credit rating. Such reports also show any UCC filings. Potential equipment
lenders are interested in the depth of a business’s borrowing history. The
longer a company has been in business, the easier it is for a lender to
determine credit stature; a good ten- or twenty-year credit history obviously
carries enormous weight. This places a startup company less than two years old
at a disadvantage. So, when traditional data sources, such as Dun &
Bradstreet and Paynet cannot supply adequate information, the personal credit histories
of a company’s owners become highly important.
CASH FLOW
- Lenders want to see that any company applying for a loan earns enough money
to meet payroll, cover fixed operating expenses, and comfortably make timely
payments on a new equipment loan or lease. While there are a number of ways to
define cash flow, lenders most often calculate the cash flow available to repay
new debt as net profit plus such non-cash expenses as amortization and
depreciation.
CAPACITY - Capacity is similar to a football team’s depth chart. The capacity
to weather bad times is equally important to a company seeking funds. Capacity
acknowledges that sometimes unforeseen things happen: a key employee becomes
unable to work; a major customer is lost; an economic turn-down drastically
reduces demand for product or services. Any number of other unlikely – yet
possible – disruptions can negatively affect a company’s cash flow. And these
disruptions can be temporary or permanent. So, capacity measures a company’s
ability to pay off an equipment loan or lease with cash reserves or its ability
to quickly convert real estate, stock, or other assets into enough funds to
cover debt.
COLLATERAL - How much collateral, above and beyond the equipment being
financed, a company needs to secure a loan or lease depends largely on the
nature of the lender and status of the business. A traditional bank often
requires a blanket lien on all assets of the business while an equipment
finance company normally uses only the equipment for collateral. A few lenders
also offer sale-leasebacks and refinancing of existing equipment debt. This
allows a company to free up cash flow or lower their monthly payment through
equipment loans or leases.
COMMON SENSE - Every decision to purchase and every decision to grant financing
must be based on common sense. A lender needs to understand how additional
equipment will increase the company’s stability and growth. Notwithstanding the
risk every lender takes and the gamble every company makes when purchasing new
equipment, for both lender and borrower, the foundation of a decision to
finance equipment begins and ends with common sense.
This article was written courtesy of Crest Capital, a commercial
equipment financing, business equipment leasing and software financing
company servicing all 50 states.
