Behind Closed Doors: Inside the Loan Application Process

Obtaining a small business loan can seem like a process steeped in mystery, especially if you’re a brand new business owner. How do you know that you’re doing it right? If you’ve ever wanted to get a behind-the-scenes perspective on what small business lenders look for when making loan decisions, then you are in luck. We’ve got the scoop on the mysterious small business loan application process from a lenders’ perspective.

These industry insider tips apply to both the loan application process at traditional bank lenders, such as Fifth Third Bank, and alternative lenders such as AOF. It’s exactly what you need to know to get approved!

The Five W’s and 5 C’s of Credit Underwriting

The decision on whether to approve or deny a loan is based on a number of related factors. When it comes to credit and business underwriting, credit assessments can be broken down into two primary areas: the 5 W’s and the 5 C’s.

The 5 W’s of Credit

Who?

The first question potential lenders will ask is who you are. Who is the owner of the company? Are there multiple owners? This is a way to assess risk – a new partnership may be more likely to fall apart, endangering the business, than an established group or a corporation. And an owner or leader with a proven track record in other endeavors is at lower risk than someone just starting out.

What?

The second question potential lenders will ask is what, exactly, your company does.

It’s important to be as descriptive as possible. Providing an accurate description of what your company does will assist underwriters in determining if your company falls into a high-risk category or industry. Being extremely descriptive also helps the underwriter assign the correct code to the company.

The underwriters will also want to know the “what” on a global scale. What industry are you in? For certain industries, such as commercial real estate, you may be assigned to a lender with specialized knowledge in that area.

When?

The third question is when the company was established.

If the company has been in business for a long time, then that is considered a positive attribute in the eyes of a lender. A sole proprietor would have the date of inception as the date they started business operations. A C Corp would use their company’s date of incorporation.

When it comes to lending or underwriting, any company which is less than two years old is deemed a startup. Startup companies’ requests for loans must be submitted as SBA loans. If less than two years old, then a lender may want the business owner to demonstrate prior or relevant business experience. Extensive or expert knowledge in a business or industry may offset the risk from a brand-new business. If you don’t have that experience, consider bringing in someone who does as an adviser, mentor, or consultant and make sure the lender knows about the relationship and the experienced person’s role in the company.

One important caveat to note: Change of legal business structure must be fully documented. If a company was once a sole proprietor and is now a C Corp, that will impact underwriting. The formal date of inception of each business entity may be different, which may need to be addressed with the lender. In other words, the most recent date may not be the right one to use, so be sure to account for any and all formal or informal changes since the very beginning of your operations.

Where?

The next question the lender will explore is where the company is physically located. Where are the company’s main operations? Does the company have multiple shops or locations?

Knowing the details of the company location can help the lender determine if the company is within reasonable proximity to their lending banks. If a business has more than one location, then it may make sense to find the lender closest to their main hub of business. In some cases, it can also help the lender judge the likelihood of success for a business – established and up-and-coming areas are more likely to support new businesses than ones that are down on their luck.

How and Why?

Lastly, these two questions are asked in tandem since they are intricately tied together. How much does the company need to borrow for its business needs? What exactly does the company plan to use the funds that it borrows for?

Be as precise as possible about exactly how much you need to borrow and as descriptive as possible about how the money will be used. Answering this component with detail shows the lender that you have a well-thought-out, executable business plan and concrete financial goals.

Being descriptive also helps the lender determine the right loan or lending product for your unique small business needs. For example, if your company is expanding and wants to buy a commercial real estate property, then the lender will be able to assess that need and work with you toward that goal. A mortgage loan may be different than a loan to lease commercial property. It’s important to be as clear, precise, and detailed as possible so that your business is matched with the best possible loan product for its specific needs.

The 5 C’s of Credit:

After assessing the five “W’s” of your small business, then the underwriter or lender moves on to the 5 “C’s” of credit. The five “C’s” are used as an informal guide to determine the creditworthiness of a small business. The five “C’s” are not stand-alone factors in determining creditworthiness, but will be used in conjunction with bank policies and procedures to arrive at an educated decision.

Character

The term character is analogous with credit history. Banks will look at both the owner’s business credit history and their personal credit history. This will include prior loans, debts, payments, and credit scores, etc.

Credit inquiries will be made to the relevant Credit Reporting Bureaus to assess these factors. Any red flags such as liens, foreclosures, charge-offs, or bankruptcy will trigger the lender to start asking questions about the story behind the deficiencies.

Note that deficiencies will not necessarily result in outright denial, but may require additional documentation from the business about the financial dings on their record.

Capacity

Capacity refers to the ability of the company to repay the loan. Capacity will examine current income as compared to existing and proposed debt. in the lending world, this is commonly referred to as “Debt Service Coverage.”

The bank wants to see a certain ratio here. Some banks also allow the lender to look at cash flow on a global basis to boost their small business capacity. Basically, this means that small business owners may incorporate their personal income and personal assets into the ability to repay their small business loans.

Capital

Capital refers to the ability or willingness of the small business to put the cash toward a potential investment. Greater capital is a huge plus in the eyes of prospective lenders. More capital represents the small businesses’ ability to withstand volatility. Capital can show that the business is ready to make a down payment on real estate, a down payment on equipment, or put it toward a cash investment start-up business.

Collateral

Collateral refers to tangible items of value that a business owner may offer to their prospective lender to secure their small business loan. Collateral can take many forms — it can be real estate, a vehicle, business or farm equipment, cash or all business assets. Banks and lenders often seek 100% collateral coverage for small business loans.

Condition

Condition has two meanings when it comes to loan applications and underwriting. Condition applies to the terms and conditions of the loan — your rate, amortization, term, payment, and guarantors. Condition also refers to any market conditions affecting your specific industry. Knowing any potential adverse conditions can help the underwriter appropriately mitigate any risk on their end.

Checking All The Right Boxes for Loan Approval

The loan approval process can feel like a black box – you’ve put in all the work to build a strong application but you can’t help but worry that you won’t get approved, or that you missed some key element in your application that would have made a big difference.

That’s where this guide comes in. Not every lender is going to spell things out as the 5 W’s and 5 C’s, but those are the things they’re looking for in an application and those are the elements you need to hit to have the best chances of approval. In addition to making sure you’re meeting the 5 W’s and 5 C’s, don’t be afraid to ask questions! The best way to learn what your lender wants is to simply ask them. Doing your homework ahead of time makes for smooth (or at least much smoother) sailing through the loan application process.

For more, visit AOF and Fifth Third Present: An Inside Look at the Loan Application Process.