In every situation where a bank lends money to a person, they intend to make a profit, not a loss. Remember that a bank is not a charitable institution but a business.
To verify that a bank will be paid back, they will make sure that there is sufficient assurance that the person in question can not only repay the loan but has met similar financial obligations in the past.
Here are the five C’s of credit that banks use to evaluate potential loans for buying a business as told by the Small Business Association:
This is the most crucial of the five C’s, where the prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the following factors:
1.) Cash flow from your business;
2.) Timing of the repayment;
3.) Probability of successful repayment of the loan;
4.) Payment history on existing relationships both personal and commercial – this one will be seen as an indicator of future payment performance.
Additionally, prospective lenders will want to know about where your repayment sources will originate.
This consists of the financing that you have invested personally in the business; more importantly, what you have at risk should the business fail. The lender and investors expect you to have contributed from your own assets as well as undertaken personal financial risk to establish the business before asking them to commit to any funding.
You can provide the lender with additional forms of security that are known as guarantees or collateral. The bank will always want to know if there is a second source of repayment should your business be unable to repay the loan. This includes equipment buildings, accounts-receivable and inventory. Both business and personal assets can be sources of collateral for a loan.
In the case of a guarantee, someone else signs a guarantee document promising to repay the loan in the event that you can’t. Some lenders may also require a guarantee with collateral as security for the loan that they issue to you.
These focus on the loan’s intended purpose such as if the money will be used for working capital, additional equipment or inventory.
The general impression that you make on a potential lender or investor is called character. The lender will form a subjective opinion about whether you are sufficiently trustworthy to repay the loan or investor and generate a return on funds that are invested in your business.
The lender will review your educational background and experience of your employees will be taken into account.