Small Business Administration – Business Loans

Obtaining a business loan, either a fixed term loan, or a business line of credit may be a challenge if your business is in the start-up phase, has been in existence for less than one year, or the business credit rating is less than what banks require. How can a business owner obtain financing when challenged with less than a great credit score?

The Small Business Administration (SBA) may be of assistance to you. What is the SBA? The U.S. Small Business Administration (SBA) was created in 1953 as an independent agency of the federal government to aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise and to maintain and strengthen the overall economy of our nation. The SBA recognizes that small business is critical to our economic recovery and strength, to building America's future, and to helping the United States compete in today's global marketplace. Although SBA has grown and evolved in the years since it was established in 1953, the bottom line mission remains the same. The SBA helps Americans start, build and grow businesses. Through an extensive network of field offices and partnerships with public and private organizations, SBA delivers its services to people throughout the United States, Puerto Rico, the U. S. Virgin Islands and Guam.

The SBA does not provide loan proceeds directly to business borrowers. Instead the SBA provides a guarantee to the lender. In order to determine if you qualify for SBA financial assistance, the borrower has to satisfy certain credit qualifications. Every applicant needs positive credit merits to be approved. Listed below are some of these requirements:

CREDIT FACTORS:

1. Equity Investment

Business loan applicants must have a reasonable amount invested in their business. This ensures that, when combined with borrowed funds, the business can operate on a sound basis. There will be a careful examination of the debt-to- worth ratio of the applicant to understand how much money the lender is being asked to lend (debt) in relation to how much the owner(s) have invested (worth). Owners invest either assets that are applicable to the operation of the business and or cash, which can be used to acquire such assets. The value of invested assets should be substantiated by invoices or appraisals for start-up businesses, or current financial statements for existing businesses.

Strong equity with a manageable debt level provide financial resiliency to help a company weather periods of operational adversity. Minimal or non-existent equity makes a business susceptible to miscalculation and thereby increases the risk of default on –(failing to repay  borrowed funds). Strong equity ensures the owner(s) remains committed to the business. Sufficient equity is particularly important for new business. Weak equity makes a lender more hesitant to provide any financial assistance. However, low (not non-existent) equity in relation to existing and projected debt (the loan) can be overcome with a strong showing in all the other credit factors.

Determining whether a company's level of debt is appropriate in relation to its equity requires analysis of the company's expected earnings and the viability and variability of these earnings. The stronger the support for projected profits, the greater the likelihood the loan will be approved. Applications with high debt, low equity, and unsupported projections are prime candidates for loan denial.

2. Earnings Requirements

Financial obligations are paid with cash, not profits. When cash outflow exceeds cash inflow for an extended period of time, a business cannot continue to operate. As a result, cash management is extremely important. In order to adequately support a company's operation, cash must be at the right place, at the right time and in the right amount.

A small business company must be able to meet all its debt payments, not just its loan payments, as they come due. Applicants are generally required to provide a report on when their income will become cash and when their expenses must be paid. This report is usually in the form of a cash flow projection, broken down on a monthly basis, and covering the first annual period after the loan is received.

When the projections are for either a new business or an existing business with a significant (20% plus) difference in performance, the applicant should write down all assumptions which went into the estimations of both revenues and expenses and provide these assumptions as part of the application.

All SBA loans must be able to reasonably demonstrate the "ability to repay" the intended obligation from the small business operation. For an existing business wanting to buy a building where the mortgage payment will not exceed historical rent, the process is relatively easy. In this case, the funds used to pay the rent can now be used to pay the mortgage. However, for a new or expanding business with anticipated revenues and expenses exceeding past performance, the necessity for the lender to understand all the assumptions on how these revenues will be generated is paramount to loan approval.

3. Working Capital

Working capital is defined as the excess of current assets over current liabilities.

Current assets are the most liquid and most easily convertible to cash, of all assets. Current liabilities are obligations due within one year. Therefore, working capital measures what is available to pay a company's current debts. It also represents the cushion or margin of protection a company can give their short term creditors.

Working capital is essential for a company to meet its continuous operational needs. Its adequacy influences the firm's ability to meet its trade and short-term debt obligations, as well as to remain financially viable.

4. Collateral

To the extent that worthwhile assets are available, adequate collateral is required as security on all SBA loans. However, SBA will generally not decline a loan where inadequacy of collateral is the only unfavorable factor.

Collateral can consist of both assets which are usable in the business and personal assets which remain outside the business. Borrowers can assume that all assets financed with borrowed funds will collateralize the loan. Depending upon how much equity was contributed towards the acquisition of these assets, the lender also is likely to require other business assets as collateral.

For all SBA loans, personal guarantees are required of every 20 percent or greater owner, plus others individuals who hold key management positions. Whether or not a guarantee will be secured by personal assets is based on the value of the assets already pledged and the value of the assets personally owned compared to the amount borrowed. In the event real estate is to be used as collateral, borrowers should be aware that banks and other regulated lenders are now required by law to obtain third-party valuation on real estate related transactions of $50,000 or more.



 

Certified appraisals are required for loans of $100,000 or more. SBA may require professional appraisals of both business and personal assets, plus any necessary survey, and/or feasibility study.

Owner-occupied residences generally become collateral when:
 

1) The lender requires the residence as collateral;

2) The equity in the residence is substantial and other credit factors are weak;

3) Such collateral is necessary to assure that the principal(s) remain committed to the success of the
venture for which the loan is being made;

4) The applicant operates the business out of the residence or other buildings located on the same
parcel of land.

5. Resource Management

The ability of individuals to manage the resources of their business, sometimes referred to as "character," is a prime consideration when determining whether or not a loan will be made. Managerial capacity is an important factor involving education, experience and motivation. A proven positive ability to manage resources is also a large consideration.

Mathematical calculations on the historical and projected financial statements form ratios which provide insight into how resources have been managed in the past. It is important to understand that no single ratio provides all this insight, but the use of several ratios in conjunction with one another can provides an overall picture of management performance. Some key ratios all lenders review are: debt to worth, working capital, the rate at which income is received after it is earned, the rate at which debt is paid after becoming due, and the rate at which the service or product moves from the business to the customer.

TYPE OF SBA LOANS:

PROGRAM: Basic 7(a) Loan Guaranty

FUNCTION: Serves as the SBA’s primary business loan program to help qualified small businesses (start-up and existing small business) obtain financing when they might not be eligible for business loans through normal lending channels. It is also the agency’s most flexible business loan program, since financing under this program can be guaranteed for a variety of general business purposes.

Loan proceeds can be used for most sound business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements, and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.

DELIVERED THROUGH: Commercial lending institutions.

SBA offers multiple variations of the basic 7(a) loan program to accommodate targeted needs.

PROGRAM: Certified Development Company (CDC), a 504 Loan Program

FUNCTION: Provides long-term, fixed-rate financing to small businesses to acquire real estate or machinery or equipment for expansion or modernization. Typically a 504 project includes a loan secured from a private-sector lender with a senior lien, a loan secured from a CDC (funded by a 100 percent SBA-guaranteed debenture) with a junior lien covering up to 40 percent of the total cost, and a contribution of at least 10 percent equity from the borrower.

CUSTOMER:  Small businesses requiring “brick and mortar” financing

DELIVERED THROUGH: Certified development companies (private, non-profit corporations set up to contribute to the economic development of their communities or regions).

PROGRAM: Microloan, a 7(m) Loan Program

FUNCTION: Provides short-term loans of up to $35,000 to small businesses and not-for-profit child-care centers for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment. Proceeds cannot be used to pay existing debts or to purchase real estate. The SBA makes or guarantees a loan to an intermediary, who in turn, makes the microloan to the applicant. These organizations also provide management and technical assistance. The microloan program is available in selected locations in most states.

CUSTOMER: Small businesses and not-for-profit child-care centers needing small-scale financing and technical assistance for start-up or expansion

DELIVERED THROUGH: Specially designated intermediary lenders (nonprofit organizations with experience in lending and in technical assistance.

PROGRAM: Loan Prequalification

FUNCTION: Allows business applicants to have their loan applications for $250,000 or less analyzed and potentially sanctioned by the SBA before they are taken to lenders for consideration. The program focuses on the applicant’s character, credit, experience and reliability rather than assets. An SBA-designated intermediary works with the business owner to review and strengthen the loan application. The review is based on key financial ratios, credit and business history, and the loan-request terms. The program is administered by the SBA’s Office of Field Operations and SBA district offices.

CUSTOMER: Designated small businesses

DELIVERED THROUGH: Intermediaries operating in specific geographic areas.

For more information about the SBA visit: Overview & History of the SBA.