Getting SBA Loans
There can be a lot of uncertainty when it comes to securing a dependable financial flow to your business. So much so that a commercial loan from a bank that’s also federally insured seems too good to believe. But backing these loans is exactly what the U.S. Small Business Administration’s Guaranteed Loans Program was built for.
So how can it be that such a large number of businesses are purposely ignoring the SBA in favor of conventional commercial loans through the underwriting process? The following article explores the ins and outs of taking out an SBA loan and will assist CPAs in determining whether or not SBA loans are a viable alternative.
UNDERSTAND THE PROGRAM
The SBA Loan Program is designed to support several aspects of small business ownership. To be considered a small business, you must prove that your business has a net worth that falls below $15 million and an after tax, 2 year net income which is no more than $5 million. In addition to these, other qualifications may be required depending on the loan for which you are applying. The following is a summarized list of popular loan programs currently being offered:
7(a) LOAN PROGRAM
This program guarantees financing to cover an array of general business needs, making it one of the more flexible loans offered. The SBA uses cooperating commercial lenders to extend guaranteed loans through this program. Loan maturities can extend to as much as 25 years on fixed assets and 10 years on working capital.
504 LOAN PROGRAM
For long-term financing at a fixed rate, this is the program you want. This loan is also guaranteed and can provide financing to expand or modernize your business. Though guaranteed through the SBA the loan is processed through a nonprofit corporation known as Certified Development Companies (CDCs). These are private organizations whose primary concern is to promote economic growth within their communities.
Income provided by a 504 loan can only fund fixed-asset projects, for example:
- Purchases of land or improvements such as grading, utilities, parking lots, landscaping, improvements to the street, or existing building.
- New construction of a facility or renovations/conversions to an existing one.
- Purchase of equipment and machinery for long-term use.
Borrowers are not permitted to use a 504 loan for inventory or working capital, refinancing, or debt consolidation or repayment. The loan’s interest rate lands slightly above current rates issued on five and ten year loans from the US Treasury. Both 10 and 20 year maturities are available. Fees can be financed right into the loan and will come to about 3% of your debenture. Typically, the assets that you are financing will serve as collateral. Additionally a personal guarantee will be required of the principal owners.
This program is meant to process smaller loans for financing working capital, inventory, furniture, machinery or equipment and supplies. These loans are delivered via intermediary lenders specializing in technical assistance and lending and are specifically designed for nonprofits and small businesses.
The terms of the loan will depend on its size, intended use, the requirements set forth by the lender and the borrower’s needs. Microloans are designed for short term use, with maximum terms reaching only six years. Interest rates will also vary, as they will depend on the lender and their expected cost to the U.S Treasury. However, you can expect the rate to fall anywhere from 8% to 13%. Credit and lending requirements will depend on the lender, but typically collateral in some form is required as well as a personal guarantee from the owner of the business.
To acknowledge the importance of small business’ role in a well-balanced economy, as well as bolster their chances of prospering, legislators passed the Small Business Jobs Act of 2010. The act serves to reinforce small business in several ways: it broadens the loans offered by the SBA, strengthens the inclination for federal projects to be given to small businesses, incentivizes exporters and beefs up tax breaks for small businesses.
WHY USE SBA LOANS?
Businesses in need of capital but unable to borrow with a conventional commercial loan will benefit from an SBA-sponsored loan. New businesses lacking an established financial history may find that a loan through the SBA is especially beneficial. Businesses experiencing financial issues can use an SBA loan to refinance debt, benefitting from their low payments and extended maturity options. Finally, businesses lacking the necessary collateral for a conventional commercial loan can turn to an SBA sponsored loan.
SBA loan adviser Cindy Watson from First Financial has said, “In this economic climate, underwriting the long-term abilities of a borrower to repay their debts is increasingly difficult, the SBA establishes a sort of insurance that allows lenders to continue servicing the needs of a borrower.”
Newell goes on to remark about the ability of SBA loans to incentivize lenders into expanding their loan terms. For example, lenders typically prefer not to offer longer-terms on working capital loans. However, under the SBA 7 (a) program, lenders can feel more comfortable with terms from 7 to 10 years. This extended maturity date results in lowered monthly payments for the borrower.
ARE THERE ANY DRAWBACKS?
When SBA loans can offer federally guaranteed money at more favorable terms, why would anyone ever choose a conventional commercial loan? For one, application for an SBA loan can require more time and paperwork from candidates than a conventional loan. Additionally, people tend to feel that maneuvering the various SBA loans can be complicated. “Essentially, the difference between conventional and SBA loans comes down to the paperwork involved,” says Newell.
The application process for SBA loans can be lengthy, Applicants do have the option of requesting an estimated time frame from the SBA before beginning the application.
Newell also reminds borrowers that a guaranteed loan through the SBA is not automatic. The underwriting process for SBA loans and conventional loans is still basically the same. Newell adds, “Frequently we’ll tell lenders and borrowers that a guarantee from the SBA doesn’t necessarily make an otherwise bad loan suddenly good.”
“Companies that are in distress financially may not be approved because, although they meet eligibility requirements for assistance, they may lack proof of their ability to repay the debt,” she says. “Applicants can still be declined for an SBA loan if they are considered a high risk borrower. Credit history has a lot of influence over those decisions.”
Also understand that by definition, a business may not be eligible for an SBA loan. Ineligible business can include nonprofits, other lenders, purveyors of life insurance, private clubs with limits on membership, or passive business (businesses in which the owner neither uses nor occupies any assets made possible with the funds from an SBA loan). Moreover, there may be additional fees with an SBA loan as they usually require guarantee fees, which could be significant if you’re borrowing a large sum.
Typically it’s wise for a business to speak with a commercial loan officer about the advantages and disadvantages of borrowing through SBA programs. Be forthcoming and proactive with your lending advisor. Be sure to thoroughly explain what you require funding for; going so far as to educate them about the service or product you want to acquire. Don’t forget to relay any extenuating circumstances that might affect your business; discuss your risks, competition and the market.
Borrowers can shore up their chances at approval by demonstrating that their project is thoroughly researched and diligently planned. Applicants would be wise to present available collateral, projections for several year-ends and debt schedules.
Include in your presentation a detailed assumption to accompany your projections and if considering a line of credit, add in your budget. Bundy says this will allow lenders to understand how funds are expected to flow through your business as well as how surpluses and gains will be timed. Include your annotated financial statements to add a level of assurance to your numbers and communicate that you’ve made the effort to seek financial advice.
In considering an application, the SBA reviews at least three of the business’ previous tax returns. Additionally they’ll want personal returns from each owner with a stake of over 20% going back three years. Finally they’ll require current financial statements from the business and borrower personally, and a resume from the borrower and any key managers involved.
A business plan is critical to your application. Your plan should be thorough and well-structured, with a statement outlining your business’s total capital needs. Your statement should “explain your business’s equity source as well as the way in which the loan proceeds will be used. Include in your plan some supporting information like a feasibility study, or an analysis of your demographics. Outline your target market and include a plan for marketing your service or product.”
To whatever extent available, SBA loans will require collateral for a fully secured loan. “Applicants who own their home will typically use it to meet their obligation of assurance,” says Newell. Additionally the SBA can put a lien on your existing business assets and require borrowers to take out life insurance if they are the business’s sole owner. “Most conventional loans are secured, and as such will require that the guarantor offer assurance in the form of collateral to be approved,” she adds.
Now that you’ve got your plan and paperwork in order, it’s time to decide which financial institutions are likely to provide funding through SBA loans. Not all banks are willing to facilitate an SBA loan. Research which banks have already underwritten multiple SBA loans and generate a list with them as potential lenders. Then, set up a meeting with a lending advisor and let them know you’re interested in discussing an SBA sponsored loan.
Assuring the bank of your viability as a lender (and your business’s viability as a successful venture) is paramount in securing your loan. If the bank doesn’t ‘buy in’, there will be no loan so don’t apply until you are thoroughly prepared.
Before submitting a claim to the SBA, the bank must ensure that all required documents are accounted for and all conditions have been met or the claim risks being denied. If the lender feels that extending a loan is not feasible, the process ends there. For this reason, it’s important that you have a list of SBA leaning banks early on. A different lender may view your situation differently.
After the bank has confirmed that everything is in order and has agreed to underwrite the loan, the documentation is sent off for review by the SBA. If the SBA decides to approve the request and guarantee the loan, funds are disbursed immediately.
IS SBA RIGHT FOR YOU?
Whether or not to pursue a loan through the SBA is a decision you must make carefully. There are numerous factors that must be considered such as selection of the right program, your personal eligibility, loan limits, fees, and potential collateral. SBA loans can be an effective way to fund the growth of your business but CPAs need to be well versed on the benefits and drawbacks of each program that’s offered. For more specific information, speak with your bank’s SBA group or seek out a firm providing SBA advising. With credit becoming a growing uncertainty, an SBA loan may be exactly what your business needs to prosper.