CLEVELAND — While Small Business Administration (SBA) loan programs can offer credit options for business owners who might not otherwise be eligible, success in getting these loans depends on mastering what lenders call the “five C’s of credit” — character, capacity, capital, collateral and conditions.
Raymond Graves, the lead lender relations specialist with the SBA Cleveland District Office, recently discussed the SBA loan programs during a Service Corps of Retired Executives (SCORE) webinar. Proving creditworthiness represents the most challenging aspect of securing business financing, he believes.
“Being eligible is one thing, but proving that you’re a great business risk is another,” he says, “and that’s probably the more important thing to be thinking through.”
Lenders use the five C’s framework to assess loan risk, Graves says. Character, capacity and capital represent areas where business owners can act to improve their standing, while collateral and conditions are often factors outside the owner’s immediate control.
In Part 1 of this series, we explored SBA loan program basics and eligibility requirements. Today, we’ll examine how lenders evaluate applications and what drycleaning business owners can do to strengthen their positions before applying.
Character: Your Financial Reputation
Character encompasses the overall impression business owners make on lenders, Graves says, particularly demonstrating that they can manage money responsibly.
“Personal credit is probably the most important element that you’ll find that banks and credit unions are using,” he says. This emphasis surprises many entrepreneurs who assume business loans should focus solely on business credit history.
The reality is that most small businesses, including dry cleaners, depend heavily on their owners’ personal financial management. Lenders recognize that owners struggling with personal finances may have difficulty managing business obligations.
For new and small businesses — the vast majority of SBA borrowers — personal credit history carries more weight than business credit.
“The lack of historical financial data and balance sheet strength makes the personal credit history of the owner much more important,” Graves says.
As businesses mature and establish independent credit histories, lenders gradually shift their focus toward business creditworthiness. However, for most drycleaning operations with fewer than 50 employees, personal credit remains crucial.
While national median credit scores approach 700, Graves sees many SBA applicants with scores below 650.
“If you find that your credit score is much below 650,” he says, “maybe the time isn’t right for you to be looking for a small-business loan yet.”
Scores above 700 create significant advantages, Graves says: “Once you’re at that 700 credit score level, you are really going to be chased by lending institutions to get financing. They’re going to make offers to you that are going to be competitive and you’re going to be able to have multiple offers.”
Lower scores limit options and increase costs. Predatory lenders target borrowers with weaker credit, offering unfavorable terms that can damage businesses long term.
The Consumer Financial Protection Bureau recommends several strategies for strengthening personal credit, Graves says: pay all loans on time every time, avoid approaching credit limits, maintain long credit histories, apply only for needed credit, monitor credit reports regularly, and prevent others from accessing your credit accounts.
Capacity: Proving Repayment Ability
Capacity is “most important because it really is whether or not your business has the ability to fully repay the loan,” says Graves. This evaluation centers on financial statement analysis and cash flow calculations.
Lenders typically request three years of business financial statements, as well as interim statements, three years of business and personal tax returns, debt schedules, financial projections, and personal financial statements.
Lenders use these financial statements, Graves says, to align multiple years of data to identify trends easily. Balance sheets provide snapshots of financial positions at specific points in time, showing assets, liabilities and net worth. Income statements reveal revenue and expenses over periods, demonstrating operational performance.
“Lenders are going to take that statement and compare and contrast what’s happened over that period,” Graves says. “Have sales been increasing? Have your expenses been increasing?”
The analysis isn’t just about numbers — lenders want explanations for trends. If wages doubled from one year to the next, they want to understand whether it reflects business growth requiring additional staff or poor cost control.
The most critical capacity measure, Graves says, is the debt service coverage ratio. This is calculated by dividing available cash flow by total debt payments.
Graves gives the example of a business with $80,000 in net profit plus $20,000 in depreciation and interest — this generates $100,000 in available cash flow. If existing debt payments total $32,000 annually and the proposed loan requires $48,000, the total debt service reaches $80,000. The ratio of $100,000 divided by $80,000 equals 1.25, indicating sufficient coverage since lenders typically require ratios above 1.2.
“You can look at your financial statements and determine what your payment ability is,” Graves emphasizes. “This isn’t that complicated. You can do it.”
Startups and businesses seeking growth capital must provide detailed financial projections demonstrating repayment ability. Graves says these projections require monthly detail showing when bills arrive and ensuring adequate cash flow during worst-case months.
Capital: Skin in the Game
Capital refers to business owners’ financial contributions to their projects. Lenders want to see owners invest their own funds alongside borrowed money, Graves says, creating shared risk and ensuring commitment.
“Lenders believe that if you have funds of your own invested in the project, it will keep you fully engaged,” he explains. “It’s also an indication of your ability in the past to save money or raise money from investors.”
For most SBA loans, owners should plan to contribute at least 10% of project costs, according to Graves. A $100,000 project should include $10,000 in owner equity and $90,000 in borrowed funds, for example.
“Approaching lenders with requests for 100% financing rarely succeeds,” he says.
Come back Oct. 2 for the conclusion of this series, where we’ll walk through the loan application process. For Part 1 of this series, click HERE.
Have a question or comment? E-mail our editor Dave Davis at [email protected].
