A lack of collateral may cause difficulty in a service based business’ attempt to obtain a loan to finance growth. To assess a borrower, lenders use what they call the Five C’s of Lending: Character, Capacity, Capital, Conditions and Collateral.
Character is the payment history of the business or owner from credit reports and other sources. The lender is trying to determine if the borrower has a habit of paying bills on time.
Capacity is the ability of the business or owner to make the loan payments. The lender will analyze historical and projected cash flow and income statements. They will use calculations like “debt coverage ratio”.
Capital is the money that the owner will invest or has invested into the business.
Conditions are the stated reason for the loan along with the current competitive and economic environment. The lender may review the company’s business plan to assess this information.
Collateral is an asset like equipment, inventory, real estate, stocks and bonds. These are items that can be liquidated in the event of a loan default.
Collateral is the area that service based businesses may have a shortage. Companies like manufacturing businesses typically have assets like buildings, inventory and equipment. Service based businesses such as engineering firms, home health agencies and marketing firms usually do not to the level of manufacturing companies.
We have found that service based businesses often need financing to support growth and expansion. The growth of these companies may begin with new expenses like additional payroll. However, it may be some time before the new payroll expenses translate into new sales, revenues and profits.
Owners of service based businesses need to plan on increased capital (money invested into the business) or pledging personal assets in order to qualify for traditional bank or SBA financing. Also, owners should consider others forms of financing like loans or investment from friends, family, business associates and factoring companies.
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