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How Businesses btain Credit

artici ant Guide

BBVA Center for Financial Education

Copyright 2018 EVERFI, Inc. 2

Table of Contents Defining Creditworthiness ........................................................................................................... 3

The Five Cs of Credit .................................................................................................................. 4

The Five Cs of Credit, Continued ................................................................................................ 5

Case Study: Sew Right ............................................................................................................... 6

Case Study: Sew Right, Continued ............................................................................................. 7

Other Considerations by Lenders ................................................................................................ 8

Other Considerations by Lenders, Continued ............................................................................. 9

Building and Maintaining Good Credit ....................................................................................... 10

Your Credit Score and Report ................................................................................................... 11

My Business Credit Score ......................................................................................................... 12

My Credit Health Plan ............................................................................................................... 13

My Business Loan Application Checklist ................................................................................... 14

Small Business Administration (SBA) Financing ....................................................................... 15

Pros and Cons of Small Business Administration (SBA) Financing .......................................... 16

Small Business Administration (SBA) Loan Programs: A Comparison ..................................... 17

Small Business Administration (SBA) Express Loans: An Overview ........................................ 18

Do I Qualify for a Small Business Administration (SBA) Loan? ............................................... 19

Other Resources ....................................................................................................................... 20


Defining Creditworthiness Creditworthiness is a lender’s assessment of how likely a person or business is to pay back borrowed money. The assessment is based on factors such as:

• Have you paid past financial obligations in full and on time? • Has your spending been prudent and within your personal budget? • Do your habits over time reflect financial responsibility?

Creditworthiness is also evaluated by whether a person or business has the income and stability to support future debt. These factors include:

• Do you have stable personal income and/or business revenue to pay all your financial obligations?

• Has your business been in existence and generating revenue for a few years? • Do you have a history of follow through, such as staying at a job and building your

expertise? The better your creditworthiness, the more likely it is that a financial institution will lend you money.


The Five Cs of Credit When you apply for a loan, the lender will evaluate your request to determine whether it is a good decision to lend you and your business money. A common evaluation framework is the Five Cs of Credit:

• Capacity • Capital • Collateral • Character • Conditions

WHAT IS IT? WHAT FACTORS DO LENDERS CONSIDER?

WHY IS IT IMPORTANT?

Capacity Your personal ability and your business’s ability to repay debts currently and in the future

Do you have enough personal income and business revenue to pay your bills, existing debts, and new debt?

Shows your ability to repay from current and future income.

Has your business shown a sufficient history of profitability?

What indicators are there that profits will continue to be sufficient into the future?

Capital The funds that you have personally invested in your business, including profits that have been retained in the business

How much of your own money have you invested in your business?

Indicates how committed you are and how much money you will lose if the business fails. Do you have family or friends who

have invested in your enterprise?

Are your assets higher than your liabilities?


The Five Cs of Credit, Continued

WHAT IS IT? WHAT FACTORS DO LENDERS CONSIDER?

WHY IS IT IMPORTANT?

Collateral Any personal or business asset that the lender can take in case you cannot pay the debt

Do you have any assets, such as vehicles, real estate, or equipment that could function as collateral?

Provides the lender a means to recoup the loan in case your business doesn’t perform well.

What is the value of those assets?

Do you have a friend or family member who is willing to guarantee the loan to supplement the collateral? (This is a legal agreement to pay the loan if the business owner defaults.)

Character Your personal and professional history of delivering on commitments

Do you have a history of paying your financial obligations in full and on time?

Demonstrates your trustworthiness and commitment to financial obligations. Do you have a good track record of

holding a job or managing a profitable business?

Have you ever declared bankruptcy?

Conditions The purpose of the loan and also the financial prospects in your industry, the economy, and any other external factors that might affect your business

What opportunities and risks does your company face from changes in your industry or the economy?

Describes how the uses of the loan and the environment will assist in your loan repayment.

What are the trends in your industry?

Are similar companies expanding or contracting?

What competitive edge does your business have?

How will the loan improve your business’s profitability, efficiency, or stability?


Case Study: Sew Right Scenario: Jovena is a 46-year-old entrepreneur who wants to expand her small sewing business, Sew Right. She started the business as a hobby from her home and began by selling to her friends and family. Two years ago, her daughter made a website for the business, and sales skyrocketed. Jovena was able to start paying off her personal loans from the income. Jovena has three credit cards: one business and two personal. She pays her credit cards and her personal loans on time. She always pays more than the minimum balance, but she has never paid off any debt in full. She owns a car that she has had for eight years and rents an apartment. Jovena hasn’t had other employment since having children 15 years ago. Question 1: Consider Jovena’s credit card history. Which “C” or “Cs” will her credit card history affect when a lender is considering whether to give her a loan? Put an X in that row (or rows) and indicate whether the effect is positive or negative.

THE 5 Cs WHAT IS IT? EFFECT + / –

Capacity Her personal and business’s current and future ability to repay the loan

Capital The funds that she has personally invested in her business

Collateral Any asset that belongs to her that the lender can take in case she cannot pay the debt anymore

Character Her personal and professional history of delivering on commitments

Conditions The purpose of her loan and also the financial prospects in her industry, the economy, and any other external factors that might affect her business


Case Study: Sew Right, Continued Question 2: Consider the number of assets that Jovena owns. Which “C” or “Cs” will her asset ownership affect when a lender is considering whether to give her a loan? Put an X in that row (or rows) and indicate whether the effect is positive or negative.

THE 5 Cs WHAT IS IT? EFFECT + / –

Capacity Her personal and business’s current and future ability to repay the loan

Capital The funds that she has personally invested in her business

Collateral Any asset that belongs to her that the lender can take in case she cannot pay the debt anymore

Character Her personal and professional history of delivering on commitments

Conditions The purpose of her loan and also the financial prospects in her industry, the economy, and any other external factors that might affect her business


Other Considerations by Lenders The 5 Cs of Credit provide a basic overview of how a lender determines creditworthiness. However, the loan evaluation process, called underwriting, usually considers several aspects of your business. The more prepared you are when you approach a lender, the higher the likelihood that you will receive the funding you seek. You should be prepared to answer the following questions (and maybe more) when you meet with a lender or fill out an application. Background and General

• When did the business start? • How is the business incorporated? • What will the funds you are requesting be used for? • How did you determine how much financing you require? • Are you able to put any of your own funds, or money from friends and family, toward

meeting this need? • Do you have a friend or family member who is willing to guarantee the loan? (You will

also be asked to personally guarantee the loan.) • What personal or business collateral is available to secure the loan? • What is the market value of the collateral? (Include documentation.)

Management and Employees

• What type of experience do you, and any other managers, have? • How many employees do you have? Full time? Part time?

Business Operations

• What are all the products and services that your business provides? • Are all of these lines of business profitable? Which ones, and why? • Who are your clients and how many do you have? • How large are your client contracts? • Who are your suppliers? • Do you have credit terms with your suppliers? • What are the trends in your industry? • Is there seasonality to your business?


Other Considerations by Lenders, Continued Financial

• Do you have two to three years of financial statements? • Do you have two to three years of tax returns? • Is your business profitable? For how long? • Do you have a balance sheet? Is your equity positive, meaning you own more than you

owe? • Are there are any discrepancies between your financial statements and tax returns? (If

so, be prepared to explain them.) • What other personal and business debts do you have? What are your payment terms? • How do you track your accounts receivable and accounts payable? • What kind of financial systems do you have in place? Who manages these systems?

What oversight do you provide? • What have you drawn from the company to pay yourself? • Do you have an accountant? A bookkeeper?

Personal

• What is your or your family’s personal financial budget, and what sources of income are available to cover your living expenses? (Most lenders will provide a personal financial statement for you to fill out.)

• How is your personal credit? Are there any discrepancies that need to be explained, such as a divorce or medical issue?

• Have you or your business ever applied for bankruptcy? Note: A lender will have many questions to learn about your business. The good news is that the process of applying for a loan can be a great opportunity to understand your business better.


Building and Maintaining Good Credit A good personal credit score is key to obtaining financing. While many lenders will evaluate your business comprehensively, some will look at your credit score as the primary indicator for their decision, which is especially true for young or very small businesses. There are two types of credit scores: personal credit scores and business credit scores. Unless you have a larger business, most bankers will look exclusively at your personal credit score. An independent agency that tracks a variety of information calculates your credit score. Information on your credit report that is considered for your credit score calculation includes:

• Payment history: history of your payments on bills, credit cards, and loans. • Length of time your information has been reported to the credit bureau: how long your

credit history has existed. • Length of time accounts have been active. • Types of credit, such as mortgage loans, credit cards, or auto loans. • Credit utilization: your account balances compared to your total amount of credit. • Length of time at your home address. • Length of time at your job. • Number of inquiries by creditors into your credit report.

Credit scores fluctuate up and down depending on how you manage your credit. Tips to improve your credit score:

• Pay all bills promptly. • Keep balances low on credit cards. • Do not take on too much debt. • Stay at the same job and address for a long period of time. • Read and understand your credit report and make written inquiries on items you believe

are incorrect.

The primary causes that scores go down include: • Late payments • Collections (for seven years after occurrence) • Bankruptcies (for seven to 10 years after occurrence) • High debt compared to income • Too many recent credit inquiries (within the past year) • Charge-offs, which are when a consumer becomes severely delinquent on a debt (for

seven after occurrence) • Too-high balances


Your Credit Score and Report Know your credit and your rights. You have the right to request a free personal credit report once every year from Equifax, Experian, and TransUnion. Get your free report from Annual Credit Report. website: https://www.annualcreditreport.com phone: 1-877-322-8228 Order your personal credit score. You can obtain your personal credit score for a fee from https://myfico.com. Order your business credit score. You can obtain your business credit score for a fee from:

o Dun & Bradstreet at https://businesscredit.dnb.com o Equifax Business at https://www.equifax.com/business/business-credit-reports-

small-business/ o Experian Business at https://sbcr.experian.com/

• Another business credit score is the FICO Small Business Scoring Service (SBSS) score, which pulls from your personal and business credit and ranges from zero to 300.

• You can’t access your business credit reports for free, but you can do so for a fee from Dun & Bradstreet, Experian, and Equifax.


My Business Credit Score A business credit score is primarily used for more mature businesses. To establish business credit, review the following questions and check off those that you have already completed:

c Do I have a business credit card? c Do I use my business credit card to make purchases for my business? c Do I have a Data Universal Numbering System (DUNS) number? c Do I have a Tax ID number? c Do I pay my creditors early or on time? c Are the following records up to date?

o State filings o Business licenses o Credit report profiles

§ Dun & Bradstreet § Equifax § Experian

c Do I have established trade lines with vendors? c If not, list at least three vendors with whom I must start a trade line.

Remember, these vendors can be any vendors that supply services or distribute goods to my business, including office supply vendors and equipment distributors.


My Credit Health Plan Review the following actions to change or improve your credit health.

1. Put a checkmark next to each step that you already do. 2. Circle each action step you want to take and write down a date by which to complete

each action step. 3. Check back on this plan frequently to mark completed action steps and set new goals.

ALREADY DO ACTION STEP COMPLETE BY COMPLETE?

Reflect on my bill-paying habits.

Request free copies of my personal credit report and business credit score and contact the agency to correct any inaccuracies.

Find out if my financial institution or credit card company will give me my credit score for free.

Determine which factors that affect my credit need the most improvement.

Develop a strategy for repaying debt.

Establish a plan to pay bills on time and in full.

Keep both overall use on my credit card(s) below 30% of credit card limits.

Know which lines of credit are the oldest, and keep them open.

Carefully consider all future offers of credit.


My Business Loan Application Checklist Below is a list of documents that you may be asked to provide with your loan application. Which of these do you already have or need to work on? Put a checkmark to indicate the current status of the document.

DOCUMENT NAME HAVE IT

AND OKAY WITH IT

HAVE IT BUT NEED TO

WORK ON IT DON’T

HAVE IT NOTES

Business credit application

Personal credit report (will be pulled by bank)

Personal tax returns, 2–3 years (depending on credit request)

Business tax returns, 2–3 years (depending on credit request)

Business financial statements and current interim statements, 2–3 years (depending on credit request)

Personal financial information, current

Sales contracts/purchase orders, if purchasing equipment or real estate

Documents for any current loans or business lease agreements

Your business license and proof of a business checking account

Disclosures if you own any other businesses or if your business has any partners

Business plan (a plus but not required)


Small Business Administration (SBA) Financing What Is SBA Financing? An SBA loan is a government-guaranteed loan program from the SBA. It is offered by banks that participate in an SBA financing program. These loans are partially financed by the SBA and help borrowers who may not qualify for traditional loans. Uses

● Any business-related purpose, from working capital to equipment purchases and even debt refinancing; different loan programs have different purposes.

● Borrow a sum that is less than your lender’s minimum. Best Practices

• Have a good credit score. • Have a strong business plan. • Be ready to provide documentation, such as financial statements, business credit

history, and a detailed plan for how you intend to use the loan. For more information, go to the Small Business Administration’s website at https://www.sba.gov.


Pros and Cons of Small Business Administration (SBA) Financing Review this chart to learn more about the pros and cons of Small Business Administration (SBA) Financing.

PROS CONS

Longer maturities to help improve cash flow. May require collateral.

Lower equity requirements, with as little as 10% down for real estate.

Lengthy application and approval process. Some financial institutions may

be able to process applications more quickly, especially if they are preferred

lenders. Speak with your financial institution representative to learn more.

Creative loan structures and more flexible underwriting parameters.

Ability to use projections when calculating cash flow requirements.

No balloon payments.

Closing and soft costs can be rolled into the loan.

Your financial institution may be an SBA preferred lender, which speeds up approval and closing time frames.

Designated SBA specialists help you throughout your project.

Short-term SBA Express lines of credit and loan applications can be processed

quickly.


Small Business Administration (SBA) Loan Programs: A Comparison Here is an overview of the SBA loan products:

SBA LOAN PROGRAMS

BASIC 7(a) LOAN 504 LOAN SBA EXPRESS AND VETERAN

Amount Maximum loan available: $5 million

Maximum loan available: $5 million

Maximum loan available: $350,000 and guarantee fees waived

Features Fully amortizing government-guaranteed loan

Business operational for at least one year Line of credit or fully amortizing loan with a partial government guarantee Guaranty fees are waived if the borrower is a veteran or the loan is for less than $150,000. Expedited application processing; may be processed in 36 hours. Higher interest rate.

Purposes Loans are offered for general working capital, expansion, and equipment purchases.

Loans are offered for owner-occupied real estate acquisitions, construction, and heavy-equipment purchases.

Loans are offered for working capital, equipment, business acquisition, real estate purchase or facility expansion, seasonal line of credit, or inventory or to refinance debt (for compelling reasons).

Loan Structure 10% down payment by borrower, 90% bank loan

10% down payment by borrower, 40% by SBA, 50% bank loan

Down payment as low as 10%


Small Business Administration (SBA) Express Loans: An Overview What Is an SBA Express Loan? This is a loan program for small businesses with an expedited turnaround time of 36 hours. The SBA guarantees up to 50 percent of the loan. For loans between $25,000 and $350,000, lenders may enforce their own policies. Who Is Eligible? The SBA decides whether a borrower is eligible, but the lender makes the final decision to extend credit to the business. Some financial institutions and lenders may have preapproval, though, to evaluate eligibility and offer the loan. Speak with a representative from your financial institution to learn if they have been preapproved. What Is the Maximum Amount? The maximum is $350,000 and may adjust from time to time. What Is the Interest Rate? The interest rate is negotiable between lenders and borrowers, but it cannot exceed SBA’s maximum. The lender may charge up to 4.6% to 6.5% over the prime rate. What Is the Repayment Schedule? Lines of credit may be repaid for up to seven years. Term loans terms typically may be repaid for up to five to 10 years for general purposes and 25 years for commercial real estate. What Can I Use It For? The SBA Express loan can be used for working capital, equipment purchases, business acquisition, real estate purchases or facility expansion, seasonal line of credit, inventory purchase or refinancing debt (for compelling reasons). To learn more, visit https://www.sba.gov/content/sba-express.


Do I Qualify for a Small Business Administration (SBA) Loan? SBA loans can take time, and they require substantial documentation. Use this checklist to determine whether you are ready to apply for an SBA loan.

c My business credit report and score are good. c I know who my lender is. c I know my lender’s minimum loan amount; it is $___________________. c I have never defaulted on a loan. c I have never been listed as an “ineligible business” by the SBA. c I have the following documents:

c Personal and business income tax returns c Business plan c Balance sheet and income statement c Personal and business bank statements c Driver’s license c Commercial leases c Business licenses c Articles of incorporation c Resume c Financial projections or statements

c I have collateral.


Other Resources Community Development Financial Institutions (CFDIs) Financial institutions also partner with organizations to offer alternative funding. Speak with a representative to learn more. Community Development Financial Institutions (CDFIs) CDFIs are nonprofit funding organizations. They range from banks and credit unions to some venture capital providers. CDFIs work primarily at the community level to provide business mentorship, financing, and technical assistance to borrowers who may not qualify for traditional financing. Go to https://www.cdfifund.gov to learn more. See if you qualify for additional loan programs. You can find a CDFI that provides loans in your area through the federal CDFI Fund at https://www.cdfifund.gov or through Opportunity Finance Network, the national CDFI association, at http://ofn.org/. Other Funding Avenues Many lenders may have special programs for businesses owned by Native Americans, women, veterans, minority groups, and people who are economically disadvantaged. There may also be programs available through state or local economic development organizations. Look for programs in your state that you may qualify for.