the borrower to make ongoing draws against and payment to a line of credit for a period of time. In both cases it is standard practice for the lender to seek personal guarantees by the owners for the debts of the business and to require the business to obtain life insurance payable to the lender on the death of an owner. For new businesses seeking first time or early time financing, it is most common for commercial lenders to use the owner’s personal credit score and history in making a loan to the business. Credit Analysis Historically, banks have engaged in review of loan applications using the “Five Cs” of credit analysis: • Character . Banks are unwilling to lend to a person, natural or corporate, whose character is such that it has involved activities like loan defaults, write-offs, fraud, litigation, unwillingness to cooperate with the bank, improper use of funds, or any other activity that necessitates the bank’s expenditure of time, effort, and expense to remedy a problem loan caused by the borrower’s action or inaction. • Capacity . This is a measure of the borrower’s ability to continue to have the business operate as a going concern that is able to stay current with its financial obligations and repay the loan. To assess this capacity a lender looks at current financial statements for an operating business or pro forma estimates for a potential or start- up business. Also included in the assessment are the experience and ability of the business owner, the nature of the business and its position in the market. • Capital structure . Banks want to see that the business owner has his or her own money in the business. This is taken as an indicator of seriousness of purpose and an incentive to the borrower who, like the bank, runs a risk of major loss if the business fails. The presence of equity also provides a source of capital that can be drawn on in the course of regular operations. • Collateral . Collateral is a bank’s claim on the assets of the business in case of loan default or business failure. Banks will also frequently require the business owner to provide collateral in the form of personal assets (for example, the owner’s house or stock portfolio). 35
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