Securing an SBA Loan
In the wake of the credit crunch, the U.S. Small Business Administration’s role in helping to guarantee loans for small companies has become more important than ever. Ever since Congress created the SBA in 1953, this federal agency has helped guarantee millions of loans to small and mid-sized businesses, in addition to providing counseling, contracts, and other forms of assistance. The idea behind the SBA-backed loans was that the commercial banking system wasn’t offering small business owners the same types of access to capital to start, grow, and keep their businesses functioning that those financial services institutions offer to larger businesses — given that they often have more assets and collateral, a larger cash flow, and a lengthier and more proven credit history.
The SBA does not make loans itself, but rather establishes guidelines for loans that it will guarantee made by a range of partners, such as banks and other lenders, economic development organizations, and micro-enterprise lenders. By guaranteeing that the loans these institutions make to small business will be repaid, the federal government diminishes some of the risk to financial institutions so that they are more likely to consider lending to small businesses — businesses they likely would have turned down without those guarantees.
The truth is that many small businesses fail and there are a variety of reasons for this — under-capitalization, lack of planning, or the person who owns the business is really good at one thing but bad another. For example, they may be good at baking cakes but maybe they don’t know how to read financial reports. But after the credit crisis that started in 2008, banks seized up on loans to businesses and individuals and, in general, were lending only to established large businesses that were already highly capitalized. In this climate, SBA-backed loans became all the more important as a lifeline to small businesses and the federal government acted to lower rates and increase the amount of small business loans they would guarantee for banks, from 75 percent to 90 percent in some cases.
Your business needs to meet the SBA’s size requirements. In order to qualify as a small business, your firm needs to meet the government’s definition of a small business for your industry. Some industry size requirements are based on average annual receipts; other industries are judged based on the number of employees, which generally can’t exceed 500 workers — although there are exceptions. The SBA maintains an exhaustive list of size requirements broken down by industry.
Types of SBA Loans
SBA loans come in several types, with different allowable uses. Most of these loans can be used for working capital, to renovate business facilities, purchase equipment, finance receivables, and in some cases, finance the purchase of company facilities. Existing businesses and start-ups can qualify for SBA business loans, but some lenders do not fund start-ups.
Before applying, it is best to do your homework about the different types of loans. Most are known by names that reflect the section of the law that created the loan category. Here are the basic categories of SBA-backed loans:
7 (a) Loan Program
This is the SBA’s most commonly used — and most flexible — type of loan to help start-up and existing small businesses when they can’t get funding through normal channels. It was named for section 7(a) of the Small Business Act. It’s flexible because it can be used for a variety of purposes, including buying machinery or equipment or furniture, purchasing real estate, leasehold improvements, working capital or even debt refinancing. The maturity term for these loans is up to 10 years for working capital and up to 25 years for fixed assets. In general, the SBA’s maximum exposure for such loans is capped at $1.5 million and since the agency will back up to 75 percent of a 7(a) loan that means a business could borrow up to $2 million.
Within 7 (a) loans, there are different types, including:
- Express Programs: This includes SBAExpress, an accelerated loan that promises a response to an application within 36 hours. The maximum guarantee for these loans is 50 percent. Other categories include Community Express, for businesses needing financial and technical assistance in underserved communities, and Patriot Express, which are designed for businesses majority-owned by veterans or members of the military.
- Export Loan Programs: These are designed to help companies that export with loans and working capital.
- Rural Lender Advantage Program: These loans are designed to promote the economic development in rural communities, in particular communities that are losing population, have high unemployment, or are losing industries.
- Special Purpose Loans Program: This category includes help to businesses for a range of reasons, from negative impacts from the North American Free Trade Agreement to helping implement pollution controls to providing assistance to Employee Stock Ownership Plans.
CDC/504 Loan Program
This is the type of loan that provides small businesses with long-term, fixed rate funding to buy generally real estate or machinery or equipment for expansion or modernization. A private lender must agree to cover up to 50 percent of the loan. Meanwhile, a Certified Development Company, which is one of hundreds of private, nonprofit corporations designed to help economic development, picks up 40 percent of the loan. The borrower must contribute at least 10 percent equity. This loan involves a major capital acquisition for machinery, equipment, and/or real estate. A business may want to move out of rental space and buy a small building and this is the loan for them. They have to have 51 percent occupancy. You could not buy the building and occupy only 1 percent. The SBA’s maximum debenture is $1.5 million when companies agree to job creation or community development goals. In general, businesses are required to create or retain one job for every $65,000 funded by the SBA — although small manufacturers have a $100,000 job retention or creation requirement. That SBA contribution can go up to $2 million ($4 million for small manufacturers) if public policy goals are met, including revitalization of a business district, export expansion, minority business develop, rural development, among other goals.
For small (up to $35,000), short-term loans, the SBA’s Microloan Program may be right to give your business the help it needs. The loans may be used for working capital or the purchase of inventory, furniture or fixtures, supplies, machinery, and/or equipment. The target audience is small businesses and not-for-profit child-care centers that need small-scale financing and perhaps some technical assistance for the purpose of starting up or expanding. These loans are administered through certain designated microloan lenders, which are nonprofit organizations with experience in financing small loans and providing businesses with technical assistance.
Applying for an SBA loan is like applying for a regular commercial loan — except this may be the last resort for your businesses because you have to have been turned down for a business loan on your own. It is not as simple as walking into an SBA office and asking for a loan application. You need to do all the necessary homework and put together all the necessary paperwork that you would before approaching a commercial bank. That means you need to review your personal credit history and be prepared to discuss. You need to assemble the historical financial reports from your business and you need to have a business plan.
Most borrowers should seek some assistance from a party who has experience in preparing SBA loan packages and is aware of the lenders’ criteria. This is why ABMI assists buyers in preparing and submitted loan packages to various lenders.
The following steps will help you put together a winning SBA loan package:
- Review your credit report: A major consideration for a lender to make a loan is the ‘character’ of the borrower. Lenders want to loan money to people who have a positive track record for paying their obligations as agreed. The “Fair Isaac Credit Score” (FICO) is one measure used to evaluate character. Credit scores can range from 300-850, and it is very important that you have a relatively high score to be able to secure a SBA loan. While some SBA loans may be made with FICO scores below 700, potential borrowers with scores in the high 700s or 800s are generally greeted with respect by lenders. You can review your credit reports — for free — from all three credit-reporting companies — Experian, Equifax and TransUnion — once per year to insure that they are accurate. You need to be prepared because the bank will pull the credit reports on you. If you find mistakes on your credit reports, take steps to correct those mistakes and bring the e-mails, letters, and other correspondence with you to the bank when applying for a loan. Professionals also can provide guidance for improving credit scores. Personal income tax reports for three years will be required for all parties that own at least 20 percent of the company’s equity. A weak FICO Score from a 20 percent to 25 percent owner can badly damage the obtaining of a SBA Small Business Loan.
- Develop your business plan: You need to have a business plan that states in writing what your business is, what you need money for, and why you will be successful. If you have a 25-page business plan already, you can update the Executive Summary section with information about your financing needs. If you don’t have a business plan, you need to develop one — even a five-page document will be more impressive than none at all. Templates and software are available online to provide valuable guidance.
- Assemble a complete financial history: In addition to your personal credit information, a lender is going to want to know that your business has a stable financial history. An accurate and complete financial history is very important to lend credibility to the SBA loan request. If you are currently in business, lenders will want to see profit and loss statements for three complete fiscal years and the current year to date. In addition they will want a recent balance sheet, within the last 60 days. If you are just starting a business, this step is not required. But keep in mind that it is much more difficult to obtain SBA loans for start-up businesses than existing businesses.
- Prepare financial projections: A lender is going to want to see some evidence that you’ll be able to pay back the loan. The most important information you can provide a lender is a cash-flow projection. A monthly cash-flow projection of 12 to 24 months or more may be required by the lender; however, this period may vary by lender and/or type of business. Cash is the ‘life blood’ of small business, and you and the lender need to take precautions to be sure that you will not run out of cash. It also may be necessary to provide projections of profit & loss statements and/or balance sheets. Again, this will vary by lender and/or type of business.
- Contact lenders: You need to find a bank or lender that works with the SBA. Most leading commercial banks will offer 7(a) loans, but so do credit unions and other lenders. You can find a list of local SBA lenders by state on the SBA website. ABMI works very closely with several SBA Preferred Lenders and will be happy to guide you through the SBA loan process.