Banks use the 5 “C”s of lending to make business loans

November 30, 2011

Every lending officer in a bank is taught the “C”s of lending. Sometimes they are known as the three “C”s, sometimes as the five “C”s. It can be helpful to understand each of the “C”s and the importance they play in making a business loan.


This is the most important of all five. Character refers to the business, its management and the shareholders who are going to guarantee the loan. There is some subjective nature to this category and a good lender can know a potential borrower has good character without looking at credit reports. However, credit reports and financial statements are important. Questions that help a lender decide on the character of a business include: does the company pay its vendors on time? Are all IRS trust taxes paid current? Has the business been through tough times and did they work through them or did they file bankruptcy? Most lenders will say that they don’t want to make loans to businesses or consumers unless they are 100% confident in the potential borrower’s character.


Capacity refers to a business’ ability to take on additional debt. It is measured by looking at various financial benchmarks of a company. The bank will make a judgment about whether a business is operating within its abilities to both financially and operationally meet all its operations.


Profits being generated from operations are always the first source of repayment of a business loan. Nearly every bank loan made has collateral securing it. Even a personal guarantee from a principal shareholder is considered collateral. A lender must evaluate the collateral as a second and possibly third source of repayment if a business is unable to repay its loan. Questions a lender must ask itself are: how much is the collateral worth if it must be liquidated? How long might it take to convert the collateral into cash for loan repayment; and is the collateral hard to find and collect (such as accounts receivable)?

Some lenders like real estate because they believe it has historically been good collateral, while others prefer quicker to collect assets like accounts receivable. Every bank has its own preference. Depending on the kind of asset, a lender may discount the value when considering its value for a loan.


Banks and other lenders want to see a business borrower have some “at risk” capital in a transaction. Commercial real estate loans in Texas typically require a 10 to 25% down payment from the borrower, though it is not unusual to see real estate being refinanced at a rate of 50% loan to value. Every transaction is treated differently and other collateral the business may be willing to pledge may enhance the transaction and the increase the amount of a loan. Always remember though that the business loan being made must meet certain debt service coverage ratios. Simply put, a business must be able to repay their loan and still have monthly cash flow to safely operate.


Conditions of a business loan are the last “C”. Sometimes conditions are also known as loan covenants. The usual conditions that business borrowers must follow are: providing the lender company financial statements on a quarterly or other periodic schedule and reporting to the lender any material changes in the company’s financial position. Nearly all banks require any loans made by shareholders or company insiders to be subordinate to their loan. Many banks require key man life insurance on the principals of a company. The bank may also require the company to maintain certain financial performance ratios.

As a potential business borrower, knowing the five “C”s that lenders use may help you better understand how to have the best chance of securing a business loan when you need one.

Ebook on Business Borrowing

Topics: Featured, Blog Posts, The Corner Office

Ed Lette

Business Bank of Texas

Ed Lette is a Founder of Business Bank of Texas. Serving as a licensed CPA since 1983, Ed’s extensive experience in the banking industry has led him to become the founding president of four national bank charters including Business Bank of Texas, N.A., and the chief financial officer of five national banks during his 45 year career. Ed serves as director of the Texas Bankers Association District 4, chairman of the Executive Advisory Council to the School of Business at Texas Lutheran University, and is a life member of the Texas Association of Business.
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Guide to Business Borrowing

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