Many practice leaders discover that to grow their practice they need access to capital. As the financial advisor market has grown and stabilized, more lenders have emerged to assist financial advisors with loans for everything from acquisitions to working capital. To do this, lenders have worked with consultants to develop methods for determining the value of a financial practice. In addition to that value, lenders also look at what they call the “Five C’s” which are five components that help paint a complete picture of the overall financial health, credibility, and growth potential of a practice.
Knowing the Five C’s and preparing the necessary documentation to demonstrate your practice’s credit worthiness is essential to the success of your loan request. Those Five C’s are: character, cash flow, collateral, capitalization, and conditions.
In all lending situations, a borrower must demonstrate strength of character. Generally, this means having a sound credit report with little to no negative marks and a steady payment history. This serves as a reliable indicator that a borrower can and will repay the loan. For SBA loans, there is an extra layer to the character check which also looks at criminal history, particularly incidents of financial fraud or other items that can undermine the integrity of the guarantor or the practice.
For items on your credit report, be prepared to provide written explanations and any documentation about the item. This includes copies of correspondence, payments, and any settlements reached. For character items related to SBA, there are specific forms your lender will ask you to fill out. If you have a criminal history, you will need to provide all court documents and any other documentation and written statements that relate, especially as it pertains to the status and resolution of your issue with the court.
Cash flow is another strong indicator of a borrower’s ability to repay the loan. There needs to be a comfortable positive gap between what comes in (revenue) and what goes out (expenses). New practices and acquisitions often have to provide projections with assumptions, along with historical data to demonstrate cash flow for the new practice or expanded practice. Historical data includes both business and personal tax returns as well as past financial statements and year to date reports.
Collateral are the assets offered by the borrower to be used in the event the loan cannot be repaid. The lender will consider business assets first, but if the value of those assets is significantly less than required, they may request personal collateral. SBA Lending and conventional programs have different collateral needs. Your lender can help you evaluate your collateral position and discuss your options. Know that lenders always work with their borrowers to ensure payments can be made within the financial operations of the business and to not put assets at risk unless absolutely necessary.
This component looks at all business resources including but not limited to fixed assets, retained earnings, and owner’s equity. Essentially this encompasses all collateral, liquid holdings, and earnings. Again, this demonstrates a borrower’s financial position and ability to repay the loan. Your lender can provide feedback and insight as to what would be considered and how it would affect your position.
External factors that could affect the borrower’s ability to repay the loan are also considered. This includes market conditions, competitors, and other industry and environmental trends that could impact long-term growth. This is why lenders often ask for a business plan, which communicates how you differ from competitors, how you insulate the business to market fluctuations, and how you are evolving to meet the demands of changes in your industry. For financial advisors this can be things like outlining generational planning, client management processes and tools, revenue by service line, and sharing marketing strategies for attracting and retaining high value clients.
Overall, the Five C’s are meant to show the financial strength and integrity of the practice historically and its viability to sustain that position moving forward. Your lender can work with you to help you evaluate your current position and give you feedback on what items need to be addressed and/or improved in order to secure a loan. Which is why it’s always smart to think ahead and start having conversations with your lender well in advance of your need for a loan.
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