Know the 5 C’s of Credit Before Applying

In this episode, we connect with Jacob Pezold, the small business banking manager for Bank of America, to discuss how to get access to capital and how it is not as tough as it may seem.

Joseph: Hey, I’m Joseph and I’ll be hosting this episode of CBR’s B2U Podcast, presented by cbrbiz.com. Bringing Charlotte’s business resources directly to you. Running a small business is no easy feat. From staffing to operations to sales, it all falls on you as the business owner. And the same is true for your financials. And when we’re just getting started, access to capital can be very critical and challenging, but it’s accessible if you understand what banks are actually looking for. In today’s podcast, we’re going to be helping you do just that. And now, I’d like to welcome today’s special guest, Jacob Pezold, small business banking manager for Bank of America. Jacob, thanks for joining us today.

Jacob: Thanks for having me, Joseph.

Joseph: To get started, can you tell our guests a little bit about yourself?

Jacob: Yeah, thanks. Thanks for having me again. I’m the small business market manager for Bank of America here locally. I reside here in Charlotte and oversee the Charlotte Market for all our clients in the small business segment. And I’ve been here in the local market for going on about three years.

Joseph: Great. So Jacob, what do banks look for when considering a new credit application?

Jacob: Joseph, that’s a great question. We look at numerous things. Some of the most important that we focus on is the five C’s of credit, that’s what we call it. So it’s capacity, capital, collateral, conditions, and character. So, capacity. Capacity is essentially the analysis of whether or not the business has the financial capacity to support the debt and expenses. Typically a business we want to show from an income perspective has a dollar and a quarter coming in to support every dollar going out in debt payment. The extra 25 cents in question there, it’s there to support and provide a cushion for the business to absorb unexpected expenses or a downturn in the economy.

Joseph: Okay.

Jacob: Capital. So what’s capital? Capital is the businesses capital assets, such as cash and equipment. And what we’re looking at is whether or not there’s enough there to help support the financing that you need, right? That’s what backs the loan and the asset that you’re looking for.

Joseph: Okay.

Jacob: You and others may have invested capital in your business, but how much? Right? So the answer says a lot about whether the business is one in which the banks want to invest.

Collateral. So collateral is a…there’s many forms of collateral. Some of the key ones in components that we look for from a business finance perspective is accounts receivable, inventory, cash, equipment, and commercial real estate. Those are all acceptable forms of collateral that banks typically look forward to leverage to secure financing.

Joseph: Okay.

Jacob: In addition to that, we like to look at the value of the collateral in comparison to the loan and use that as a measurement on the amount we’ll extend out.

Joseph: Makes Sense.

Jacob: Absolutely. Conditions. So we talked about conditions. Conditions are sometimes things that are outside or are items that are outside the control of the business, such as the economy, trends in your specific industry and any pending legislation relative to your business are all conditions that we evaluate. A lot of these factors are out of your control at times, and they may affect your ability to make payments. And then lastly, character. Character is rather robust and it is an incredibly important and a key conversation for us today. So character can include experience in owning and operating a business that you’re in, and then ultimately your personal credit history, which is incredibly important in what banks will consider. Personal integrity and good standing are essential for starting out with obtaining business credit.

Joseph: Okay, that makes sense. So the five C’s flow into what type? If our business owners get everything together with the five C’s, then what type of business loans or financing should they look at?

Jacob: Yeah, and another great question. There’s so many different forms of credit available to small business owners. Some of the main ones that we see clients leverage and offer vary across the board, right? So there’s also business stages and life cycles. So whether your business is starting out or you’re in growth mode or sustaining or even working on an exit plan, there’s multiple different formats of financing available. Speaking towards clients that may be starting out right? So we can look at options from a business credit card. And a business credit card is not just necessarily for a client that doesn’t have established credit history, it’s also an excellent cash flow mechanism, right? So, to support the payables process and provide a float for the business to bridge the gap from the receivable process.

So, a credit card is also there to establish credit, right? So it could be the first form of credit that you have as a small business owner.

Joseph: Okay.

Jacob: It really is a universal tool that is essential to any business operation. Not only does it provide you a necessary breathing, the breathing room when you’re working through your business cash flow cycle, but it can also provide you with robust rewards if you’re in the right credit program that you can instill back into the business.

Joseph: Makes sense.

Jacob: Yup. And then there’s lines of credit, right? So that’s another really popular form of credit for a small business to use. A line of credit is really a…it’s somewhat of the Swiss army knife of the business finance world. What it can do is provide you ultimately with the monthly cash flow tool, it can provide you the ability to go out and make short-term expenses and handle accordingly. But ultimately what a line of credit is there for is to help bridge the receivable and payable cycle, right? So how quickly can a business get the money paid to them after they’ve paid the money out to render services?

Joseph: Okay.

Jacob: And what a line of credit can do, Joseph, is it will actually give you the ability for the business to float money to itself, and payback accordingly when they receive payment for the work rendered.

Joseph: Okay. So kind of similar to a credit card but a little bit more robust.

Jacob: Yeah, with a credit card, you’re going to want to use that for eligible expenses that a vendor or a client can accept card, right? If not, you would be looking at pretty steep cash advance fees as opposed to with a line of credit, you can advance cash at a low-interest rate.

Joseph: Okay.

Jacob: In comparison. The main difference there is that a credit card, within a statement cycle if it’s paid in full, you don’t pay interest. Lines of credit are…the interest is accumulated from the moment that the cash is advanced, but typically at a lower rate.

Joseph: Okay, makes sense.

Jacob: Yup. And then a secured loan. So a term loan financing is really, it’s there for so many different reasons, all the way from working capital to financing a piece of property, right? And everything in between. So really common needs that a term loan would fit, so if a business is currently leasing a space and paying high rent, I mean being here in Charlotte, we’re in a really competitive real estate market. So all those business owners out there listening know what I’m speaking towards.

Joseph: Yeah.

Jacob: Oftentimes, you know, when you’re operating a business, you’re thinking about the day to day, but also out there, you’re, paying rent to somebody else. A term loan, you know, either leveraging the Small Business Administration or conventional financing to secure real estate collateral, can really help you build equity in a tangible asset that you can utilize for the long run, right? So build your own equity into a piece of real estate and that’s a really common need for a small business owner looking to leverage term loan financing.

Another format would is to use equipment that’s necessary to grow and expand the business, right? So if a client needs to purchase a piece of equipment and doesn’t want to deplete their capital or their cash reserves, it can give them the ability to finance that equipment and grow the business and grow revenue while paying a low monthly fixed cost rate. And then ultimately we can finance working capital, you know, cap cash injection to the business to grow organically. There’s multiple different ways that you can leverage bank financing. I would heavily recommend that you take that opportunity to sit down with your CPA or your accountant and your small business banker at any time you can to discuss your goals when it comes to all those different opportunities.

Joseph: Okay. It does definitely make sense. And so to actually secure credit, we know the importance of having a great credit score or a good one. So what are the things that business owners can do to maintain their good credit score or improve their credit score?

Jacob: Yeah, there’s several things you can do and all of them are somewhat equally important, right? So first and foremost, make sure you pay your bills on time.

Joseph: That’s the biggest one.

Jacob: That’s a big part of the character that we talked about earlier and the ability to pay back, not just creditors, right? So conventional banks and finance companies, but also your vendors. Sometimes our clients or business owners don’t realize that there are vendors and that they can report them just as easily as a creditor can.
 
Joseph: I didn’t know that.

Jacob: Yeah. And that’s a key difference between a personal credit report and a business credit report is you’re not only just being measured for your payback on conventional credit, but also too from potential vendors. Also, reduce your debt. If you’re showing that you’re consistently over leveraged and you’re not making any type of principal pay down, it can show a bank or another lender that you’re really not making the right steps to reduce debt and retain more capital. And that can cause a red flag.

And then what’s really important ultimately as well as that you’ve got to check your credit report regularly. If you’re not checking it consistently and looking at it and looking how vendors or creditors are reporting you and your creditworthiness, you really are leaving it up to chance. And there’s inaccuracies out there and it’s really important that you’re on top of it and can understand it and check that. And then a big one that’s, I think universal, whether it’s a business or personal credit is, make sure that you have multiple forms of credit and that you can show the repayment history at handling multiple forms of credit. Oftentimes when we pay something down really quickly, we want to close it down and show that, hey, I’ve paid that obligation and I’ve closed the account.

It’s really important to not do that.

Joseph: Okay.

Jacob: And the big reason for that is to show that you’ve got your age of your accounts and your ability to hold an account open, is at least scrutinized. So when you pay down an open trade line, like a line of credit or a credit card, first and foremost, don’t close that down from the perspective of an age trade line, but also too, that’s accessible capital for your business that you may need at some point.

Joseph: Okay.

Jacob: Some of the most important parts is to update your business profile, which is a little bit unique in comparison to your standard credit report is making sure that your business profile’s up to date.

Joseph: That makes sense. Now, you kind of mentioned a couple of things that seemed very similar to your personal credit score or your personal credit report.

Jacob: Mhm.

Joseph: What would a business credit report kind of look like versus a personal?

Jacob: Sure. So a business credit report is going to be a little bit different and unique compared to a personal credit report as there really isn’t any standardization in it, right? So a report from one vendor, it may include information from a vendor that’s not choosing to report to the other agencies.

Joseph: Okay.

Jacob: So it’s really important to make sure that you’re checking on the main key ones, which would be Dun’s and Brad’s or LexisNexis are two main ones that the banks use, all those should ring a bell. But the variation between the two and then the, ultimately the business profile that is updated by you as the owner is something that’s a key difference.

For a personal credit report, you know, it’s reactionary. You make payments, creditors either tell you, tell the agencies, which is Experian, TransUnion, and Equifax that you either paid them or you didn’t.

Joseph: Right.

Jacob: And it’s rather seamless process for us as consumers.

Joseph: Right.

Jacob: What’s really important for a business owner is that they actually create and update their business profile. It’s essentially them telling the story to the agencies to report to us as lenders.

Joseph: Okay, makes sense. So something that may be kind of new for our listeners is a business profile.

Jacob: Sure.

Joseph: So what should be included in someone’s business profile?

Jacob: Yeah, another great question. And this is something that, you know, when I’m around in the market, I actually get these questions quite often, and exactly what is in a business profile or you know, when we go to reference the information that might be on Dun and Brad’s, they say, well, I don’t know where that came from. And it’s really interesting to know that you actually have to go in and update these agencies, right? So you have to go in and provide your business profile. So that’s the first thing to discuss is that you actually have to go in and provide the information necessary. It might be reported, but it’s not your story. So you wanna make sure you tell it.

But in a business profile, what it does, it helps banks determine how much credit to extend and whether or not to approve you for credit essentially, right?

Joseph: Okay.

Jacob: Your ability to handle business debt. Your profile can include things like the size of your company, the number of employees you have, and where you are located.

Joseph: Okay.

Jacob: A big part of that is how we evaluate is the size of the company. How do we segment and size you into a relationship at a bank or how do we handle the amount of employees and the needs that you have on that side? So it’s really important to update that information, so banks can leverage it and make sound decisions.

And then ultimately what you need to do is you need to contact the major bureaus and ask for your company’s profile. That would be a great first step. Find out what actually is being reported about you if you don’t know, that would be a great initial step. And then take necessary steps and get advisement from either a small business banker or your accountant or just a trusted adviser in the small business community about how you should properly update your profile and reflect with the agencies.

Joseph: Okay. So before applying for credit, what is one of those things that you think that all business owners should know or kind of take the step to do right before applying for a business credit?

Jacob: Yeah. This is a question I could probably expand on for quite awhile, but again, it kinda goes back to the stages and life cycles of the business at hand. You know, again, whether you’re starting out or you’re in growth mode or you’re winding down or even exiting, there’s so many different formats in financing available. It’s really important to understand where you’re at in your business life cycle and what your priorities are. When you’re starting out things that are really important, items that are really important are personal creditworthiness. Oftentimes, you know, when there’s a lack of business history or there’s a track record there to show that you’ve operated and owned a business and you have a financial backlog to show it and your ability to effectively grow a business, your personal credit is leveraged. It’s what we have to go off of. And it goes back to that character thing again, right? So, how you’ve handled your personal debts, how you’ve handled your personal finances are critically important to obtaining financing. And it can even be in the form of a business credit card when you’re starting out.

You know, if you’re in a growth model and you’re trying to grow your business and expand, you know, what type of capital have you used and what kind of capital do you have? How are you handling your income as opposed to debt? Are you reporting enough income on your returns to show that you can support the debt that you’re trying to obtain? Right? That’s really important. We definitely leverage the business reported income and the personal reported income to service both the personal and business debt. And that’s a really important facet of it as well.

But again, going back towards all of these different items, it goes back to the five C’s, right? Pay attention to the request in hand, you know.

Joseph: Right.

Jacob: Seek out the credit opportunity early and get the advisement early on. And the more you’re prepared to go into an application to obtain financing, the better. So if you have a goal in mind, whether it’s, you know, next month or two to three, four or five plus years out, it’s really important to vocalize that with the individuals that are here to help. Because our job and what I so passionately teach and educate my folks on is that you are aware of what your client’s needs and goals are. You have to know what your priorities are and know how we can help accommodate them. And the earlier we know that, the more that we can help better prepare and that’s so important. Being prepared for obtaining credit and going into it is almost everything, right? You don’t want surprises. So meet early and often with your accountant, your banker, anybody that’s a trusted adviser in your small business community and just vocalize about what your goals are and seek advice from multiple different channels on how to obtain them.

Joseph: Makes a lot of sense. Now in a perfect world, everybody’s going to get approved.

Jacob: Sure.

Joseph: But sometimes people won’t. And so if a small business owner is turned down for credit, do you have any advice for them or what their response should be?

Jacob: To your point, it’d be great if we could extend financing to anybody that needs it. But unfortunately, that’s not the case. And one thing I would just want to educate a small business owner on is to, don’t be dejected, don’t take it personal. There’s typically a root cause to it and there’s typically a solution to it, right? And it’s what you do after that point that’s important. How much more education can you have? How could you remedy the situation at hand? It could be for multiple different reasons as to why we weren’t able to obtain or give financing to you at a certain time, but that doesn’t mean that it’s not possible with a little bit of work and attention to what caused the decline in the first place. Some different reasons that a client could get declined could be issues with the personal credit. If they have a bankruptcy on file or some negative information being reported about payment history

Joseph: Mhm.

Jacob: Or it’s simply if they’re over-leveraged on as an individual.

Joseph: It kind of flows into the character part.

Jacob: Exactly, right. It’s a big part of that. And then whether or not we can even finance your industry type. Or, we talked about the conditions, right?

Joseph: Right.

Jacob: So there are some things that are out of even your control as an owner, right? Or the business operator that our economic conditions or industry regulation that arises and that can heavily impact a business, depending on their client base. So that could be out of your control. And then also if there’s issues with your business financials, right? So maybe you don’t have enough income on display to cover the debt that you’re seeking or the finance structure that you need. All those are different reasons. But again, all of them are an opportunity to look at it in the future and continue to work into a place that you can obtain financing in the future.

Joseph: Okay. So sometimes you won’t get the financing from a traditional bank. Are there any other options for small business owners if they can’t get approved with a traditional bank?

Jacob: Yeah, there absolutely is. You know, if a business has been turned down by a bank, we always want to recommend a community development financial institutions, often referenced as a CDFI. These are great options for clients. They are lenders that help certain small business owners gain access to capital, right? So Bank of America works with many of them. For example, here locally we have a partner in Charlotte. It’s the Carolina Small Business Development Fund.

Joseph: Okay.

Jacob: The approval rates with CDFIs are typically a little bit higher, and they’re geared towards, you know, all different facets of the business life cycle, but typically where they really help is the early stages of a company or a startup. And they also, in conjunction to providing possible financing, they offer education, support, and in a lot of different areas that we talked about earlier that can get a business geared up and ready for conventional bank financing.

Joseph: So before we wrap up, is there any other advice you would give our small business owners?

Jacob: Yeah, I have a lot of advice. I would love to expand and, you know, just know that you know more than anything, there’s a lot of resources available to you when it comes to lending advice, support, and guidance. The one thing that’s great about the local small business community is it’s a passionate group. There’s so many different network opportunities and it’s just a wonderful small business community here that we have in Charlotte. So take advantage of those opportunities, right? It doesn’t always just have to necessarily be with a banker or your accountant. There’s just so many different great, excellent groups to be a part of. For example, NAWBO here locally is the National Association for Women Business Owners. Actually not local. A national organization with a local chapter here in Charlotte, where they provide a ton of great resources and education and just peer to peer networking, as just an example. But also to meet routinely with your small business banker and do so in conjunction with your accountant or your CPA or your trusted advisers.

But that should be at a minimum, a biannual review of your business. You know, oftentimes we field requests and are reactionary to them, as opposed to help prepare. And I feel that it’s necessary if you really are looking to grow and establish a business and obtain financing, you do so through the proper preparation. And that includes just communication and advisement, with your advisers, right? Or your trusted advisers. But there’s also a lot of different resources here that we have at the bank for the small business community. You can go to our website to review these. It’s bankofamerica.com/sbc. And with that, there’s a ton of resources for our clients to leverage, and in addition to meeting with their local banker.

Joseph: I appreciate it. I think our listeners are going to really enjoy getting some additional information in regards to business financing and thanks so much for joining us today, Jacob. Listeners, if you have any questions after this episode, tweet us @CBRBiz. This has been CBR’s B2U podcast, brought to you by cbrbiz.com. Until next time, we mean business.

Do you have a topic you’d like to hear us cover on our #B2UPodcast? Tweet us @CBRBiz!

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