Need a Loan for Your Business? As a company grows, inevitably it will need to partner with a bank to provide long-term financing and additional working capital. Over the years, I have been involved with many clients that struggle to get traditional financing. The response that my clients usually get upon applying for credit is “we like the business model, but it is just ‘not’ the right fit for the bank.” After applying to five different banks, it is quite possible to receive five different reasons for not being a good fit. Maybe it was a ratio, type of industry, or the type of collateral that triggered the rejection. Whatever it may be, the bank says to come back in six months and we can look at it again; the only problem is that many small businesses might not have six months to wait and reapply.
There is a solution for companies that are operating at a profit but don’t have a significant amount of equity built up. Recently, I have worked with a client that is being forced out of bank. While they are current on the payment terms for loans outstanding at his bank, the business incurred some significant losses in 2013 due to a change in the business model that would allow the company to make more money in the future. The company funded the losses by a loan provided by a minority investor. Despite the fact that the minority investor with deep pockets guaranteed the loan, the bank downgraded the loan internally, froze the line of credit, and required the owners to pay down the line of credit by 40%. From that point, the bank was unsure of its next step, since the client’s company started making money in 2014 and is doing fantastic in 2015. So my client and I kept meeting with his banker on a quarterly basis for a quarterly renewal/extension of the loan. Each meeting they just nicely asked for us to pay down the line of credit more and more to squeeze as much cash out of the company as possible. The main problem with that was he was growing and his inventory and receivables were going up which required more cash.
No problem, right? Just go down the street to a new bank and get the better treatment that your company deserves. The only problem with my client was he did not fit in the “traditional lending” platform primarily for not having two full years of net income. For most banks, if you’re not in the black for two years it is difficult to pass the loan committee review.
So who did we turn to for help? Believe it or not- our very own government. Most people don’t know that the Small Business Administration was established to assist small business owners by providing resources and programs to benefit the community. They have a loan program called the SBA 7(a) loan that, in certain cases, makes securing a loan a lot easier for qualifying businesses. Qualifying businesses vary by industry and may be defined as a small business based on either revenue size or the number of employees.
The SBA 7(a) loan program is not a loan directly from the SBA. Instead, the SBA guarantees loans underwritten by traditional lenders. Lenders have to qualify with the SBA to provide these loans and there a several types of certified lending programs they fall under depending on the circumstances of the applicant. These programs vary slightly, however, under the standard 7(a) process lenders submit a full application package to the SBA when they request an SBA guaranty. The SBA confirms the originating lender’s credit decision with its own analysis of the application, which typically takes five to ten business days.
There are some advantages for banks to lend under the 7(a) loan program:
- It helps banks serve customers that don’t meet the standards of a conventional loan, which allows them to generate new revenues they wouldn’t otherwise be able to generate.
- It reduces the bank’s portfolio risks due to the SBA guaranty
- Due to the SBA guaranty, it lowers a lender’s risk weighting for meeting capital requirements.
The SBA 7(a) loan program provides an 85% guaranty for loans of $150,000 or less and a 7% guarantee for larger loans. The amount of the guaranty is reduced to 75% as the size of the loans decreases. The maximum SBA 7(a) loan amount is $5 million.
In addition to the revenue and/or employee headcount guidelines, there are additional eligibility requirements for businesses applying for loans under these programs such as:
- Operate for profit
- Be engaged in, or propose to do business in, the United States or its possessions
- Have reasonably invested equity
- Use alternative financial resources, including personal assets, before seeking financial assistance
- Use the funds for a sound business purpose
- Not be delinquent on any existing debt obligations to the U.S. government
There are certain business types that are ineligible because of the activities they conduct such as:
- Lenders such as banks and finance companies
- Real estate development
- Life insurance companies
- Multi-level marketing companies
- Government owned entities
- Promotion of sexually oriented products or services
- Oil and gas exploration
The SBA 7(a) program was established to encourage longer term financing. There are various factors to the actual term assigned to a loan, however, maximum loan maturities have been established: 25 years for real estate, up to 10 years for equipment, and generally 7 years for working capital. Applicants can request interest-only payments during the start-up and expansion phases to allow the business time to generate income before it starts making full loan payments.
The SBA expects every 7(a) loan to be fully secured, but may not decline a request to guarantee a loan if the only unfavorable factor is insufficient collateral, provided all available collateral is offered.
There are two types of costs related to 7(a) loans. These are loan origination fees and interest charges. The loan origination fees vary based on the size of the loan and range from 0.25% of the guaranteed portion of the loan to 3.5% on loans of more than $700,000. There is also an additional fee of 0.25% on any guaranteed portion of more than $1 million.
All interest rates vary depending on the negotiations between the bank and the applicant, however, the rates are subject to the SBA maximums. The rates can also be either fixed or variable. The maximum rate is composed of a base rate and an allowable spread which will be no more than 2.25% for loans with a maturity less than 7 years. For loans longer than 7 years, the maximum rate will be 2.75%.
Like most other traditional loans, there is a loan application checklist that is very thorough which tends to be one of the slightly negative elements of an SBA 7(a) loan. One of the most common challenges an applicant may face is the ability to provide financial statements that are current within 90 days of the application ‘and’ 3 years of historical financial statements. In addition, an applicant is required to provide a 2 year cash flow projection with an attached written explanation as to how you expect to achieve this projection. From my experience and from conversions with SBA lenders, this is one of the most common pitfalls an applicant may face when trying to get SBA loans. The most likely cause of the lack of reliable financial information is due to the owner being more focused on growing the business than on the quality of the financial statement preparation. They typically rely on a back office that is spread too thin with administrative duties and getting their billings out on time.
That is where can help. Not only can we help you produce timely and accurate financial information, we can help increase the value of your company by helping you improve your core administrative process. The first step is to begin automating your processes. You also need to develop processes to make your business smarter and more efficient to reduce costs and increase productivity. Here are some examples:
- Eliminate cumbersome and time consuming manual tasks such as: data entry, envelope stuffing, filing and check runs
- Pay bills online at a fraction of the time it takes to process and sign checks
- Automate customer collections
- Stop opening mail by having the vendor emails sent directly into the accounting software
- Reduce human error and increase accuracy with automated software
- Improve internal controls to reduce the risk of fraud
- Improve timely reporting of financial results
- Improve collaboration of your limited resources
Free up your resources to focus on your team and customers which will ultimately help you grow the company and have the peace of mind that your company is operating in a smarter and more profitable way. Go and Grow can help you put the processes in place and become your back office at a much lower cost with better controls.
Blog post written by: Scott Bates, Audit and Business Services Partner