Loans can be crucial tools for scaling up production, extending the growing season, reaching new markets, or, of course, purchasing farmland! But applying for a loan is a major undertaking, and it can be difficult to understand what lenders want and which type of lender is a good fit for you. The Carrot Project’s mission is to foster a sustainable and diverse food system by expanding financing available to small farms and food businesses and increasing their ability to use it. We’ve been working with farms for over 10 years and are dedicated to demystifying the process.
Banks and other lending institutions evaluate applicants based on the 5 C’s of credit. Definitions of the 5 C’s vary slightly from lender to lender. The Carrot Project uses cash flow,cash/equity, collateral, conditions, and capacity. But what do these terms mean, and how are they documented?
1. Cash flow is a detailed statement of money coming into and going out of the farm business (see a template here). A monthly cash flow statement not only shows whether your farm is profitable overall but also whether you have enough money in the bank each month to pay your bills.
2. Cash/equity refers to the personal and business assets of the credit applicant. It is documented through a business balance sheet and a personal financial statement. Equity also indicates the amount of ‘skin in the game’ an applicant has, which helps the lender understand the personal level of risk and for some lenders it is an important factor to strengthen an application.
3. Collateral means the assets that you agree to pledge against the loan amount—such as vehicles, equipment, or livestock. For larger loans, land or real estate may be used as collateral. Different lenders have different requirements for how much collateral they require and what type they accept.
4. Conditions refers to the market for your products and your ability to access these markets. Many of these factors are outside your control—such as local economic conditions—but you can address them in your business plan. It is important to demonstrate that you understand the market conditions that will have the greatest impact on your business and have planned accordingly, for instance by differentiating your products from the competition and avoiding oversaturated markets.
5. Capacity refers to your farm business management skills plus your character (work experience, credit score, and community ties). It is documented through a business plan and resumes for the applicants. Note: Some lenders define capacity more narrowly as a ratio of your revenue to debt service payments.
6. For some lenders, credit score, or FICO score, counts as its own factor. For others, it is a subcategory of capacity.
An important first step in searching for financing is to find a lender who is a good fit for your business stage and priorities. A lender can be a commercial bank, a community development finance agency, a credit union, an agricultural credit corporation, a government agency, or a nonprofit. Depending on where you live you may have access to all or some of these lenders. Each entity weighs the 5 Cs differently depending on their source of capital, mission, business model, and their target audience.
Newer lenders include crowd-sourced and commercial lenders functioning only online. These lenders vary greatly for the same reasons as more traditional lenders. Less is known about their suitability for agriculture. In most cases, there is less opportunity to develop a relationship with the institution which is important when things go bad and when you want to return for more or a different source of financing.
In all instances, it is important to do your homework and research and speak to loan officers from those that seem the most promising for you. You will learn a lot from these interactions. For an overview of financing options in the Northeast, see our Farm Financing Options page.
Looking for more help? This video explains just one aspect of using the Finding Farmland Calculator. Find all of the instructional videos at youngfarmers.org/calculator.
Create an income statement and balance sheet for your business. Use this template and the cash flow budget you made in lesson 3.
Though a lender may eventually want you to submit your financials in a different format from these templates, they will be impressed by any loan candidate who has taken the time to understand their business’s finances in such depth.