With all of the uncertainty around maintaining a predictable flow of capital to businesses, a commercial loan provided by a bank but guaranteed by the federal government almost sounds too good to be true. Standing behind such loans is one of the responsibilities of the U.S. Small Business Administration’s (SBA) Guaranteed Loans Program.
So, why do many businesses intentionally bypass the SBA and take their chances through the normal commercial bank underwriting process? This article examines the pros and cons of major SBA loan programs and helps CPAs determine if an SBA loan is the best alternative.
UNDERSTANDING SBA LOAN PROGRAMS
The SBA offers several primary loan programs geared toward supporting different aspects of the small business community. To qualify as a small business under current law, a business must demonstrate that it has less than $15 million in tangible net worth and two years’ net income after taxes of less than $5 million. From this point, various SBA programs have other qualification criteria. Here are summaries of the most popular programs:
7(a) LOAN PROGRAM
This is the SBA’s primary and most flexible loan program, with financing guaranteed for a variety of general business purposes. Under this program, the SBA guarantees loans made by participating commercial lending institutions. Possible loan maturities are available up to 10 years for working capital and generally up to 25 years for fixed assets.
504 LOAN PROGRAM
This program provides long-term, fixed-rate financing for expansion or modernization. It is backed by the SBA but delivered by Certified Development Companies (CDCs)—private, nonprofit corporations set up to contribute to the economic development of their communities.
Proceeds from 504 loans must be used for fixed-asset projects, such as:
- Purchasing land and improvements, including existing buildings, grading, street improvements, utilities, parking lots and landscaping.
- Constructing new facilities or modernizing, renovating or converting existing facilities.
- Purchasing long-term machinery and equipment.
The 504 program cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing. Interest rates on 504 loans are pegged to an increment above the current market rate for five-year and 10-year U.S. Treasury issues. Maturities of 10 years or 20 years are available. Fees total approximately 3% of the debenture and may be financed with the loan. Generally, the project assets being financed are used as collateral. Personal guarantees from the principal owners are required.
This program provides small, short-term loans for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment. It is designed for small businesses and nonprofit child care centers and is delivered through specially designated intermediary lenders (nonprofit organizations with experience in lending and technical assistance).
Loan terms vary according to the size of the loan, the planned use of the funds, the requirements of the intermediary lender, and the needs of the small business borrower. The maximum term allowed for a microloan is six years. Interest rates vary, depending on the intermediary lender and costs to the intermediary from the U.S. Treasury. Generally, these rates will be between 8% and 13%. Each intermediary lender has its own lending and credit requirements. Generally, intermediaries require some type of collateral and the personal guarantee of the business owner.
In recognition of the important role small business plays in a healthy economy, lawmakers passed the Small Business Jobs Act of 2010 (PL 111-240), which expands loan programs through the SBA, strengthens small business preference programs for federal government projects, provides incentives for exporters, offers a variety of small business tax breaks, and includes some revenue raisers. For more on the changes resulting from the bill, see the JofA articles “Act 2 for Business Tax Incentives” (this issue, page 28) and “Highlights of the Small Business Stimulus Act” (Dec. 2010, page 26).
WHY CONSIDER AN SBA LOAN?
For many businesses, the benefits of an SBA-guaranteed loan include having access to capital where traditional commercial loans may not be available. Startups and young businesses without a sustained history of financial performance may find an SBA-guaranteed loan especially attractive. For businesses with cash flow issues, an SBA loan can restructure debt at better terms by providing longer loan maturities and lower payments. Businesses without sufficient collateral to obtain a traditional commercial loan may find an SBA loan particularly useful.
“It is very difficult at this time for lenders to underwrite the strength and long-term viability of a borrower’s ability to repay the proposed debt. In this unusually challenging economic cycle where real estate values are declining, it is also difficult to ascertain the future value of collateral,” said Jan Roberts of Capital Solutions, a firm based in Birmingham, Ala., specializing in SBA loan advisory services. “SBA provides the backup ‘insurance’ in order to be able to service the borrower’s loan needs.” Capital Solutions is managed by Roberts, Nicole Reed and Mike Vance, who are loan originating agents for Foundation Capital and other SBA CDCs.
According to Roberts, the “SBA can also entice a lender to stretch out the terms of a loan. For permanent working capital, for instance, lenders normally do not want to offer longer-term loans. Under the SBA 7(a) program, however, the lender may be comfortable with a seven-to-10-year term. This serves to lower monthly payments, which benefits the borrower.”
WHAT ARE THE DRAWBACKS?
If the federal government is willing to guarantee a substantial portion of a company’s debt at favorable terms, why choose traditional commercial lending over an SBA loan? In general, an SBA loan requires more information than a commercial alternative and more time. Also, there is a perception of complexity in maneuvering through the various SBA loan programs. “The real difference between an SBA loan and a conventional bank loan is paperwork,” Roberts said.
The SBA process can be time-consuming, said Rachel Zippwald, a California Bank & Trust vice president and SBA lender. For planning purposes, applicants can request a time estimate from the SBA for consideration of the loan.
Roberts cautioned that it is important to remember that SBA loan guarantees are not automatic. SBA loans are underwritten the same way as conventional loans. “We often tell borrowers and lenders that an SBA guarantee does not make a bad loan good.
“Companies experiencing financial distress may be eligible for assistance, but may not be approved for the financing due to lack of reasonable assurance of repayment ability,” she said. “SBA can decline loans because they are determined to be bad credit risks. Credit history plays a big role in those decisions.”
Also consider that some businesses are ineligible by definition for SBA loans. Nonprofit organizations, lenders, passive businesses (developers and landlords that do not actively use or occupy the assets acquired with SBA loan proceeds), life insurance companies, and private clubs that limit membership are examples of ineligible businesses. Additionally, SBA loans can require guarantee fees that do not apply to conventional commercial loans. Depending on the amount borrowed, these fees can be significant.
WHAT YOU’LL NEED TO APPLY
Many businesses first discuss the pros and cons of an SBA loan with a loan officer at a commercial bank. Dan Bundy, a vice president at Regions Bank who has specialized in SBA lending during his 25-year career, suggested approaching SBA financing in the same manner as any other loan request. Be proactive with your banker and provide as much information as possible. Educate your banker on the product or service for which you need funding. Discuss the market, the competition and the risks, as well as the mitigating factors involved in your business.
“It goes a long way in giving some comfort to the fact that the project has been thoroughly researched,” Bundy said. He suggests including a presentation on available collateral, debt schedules and projections broken out on a monthly basis for the first year and at least two more year-ends.
Detailed assumptions should be given for the projections, Roberts added. Include a cash budget, especially when considering a line of credit. “This allows a banker to understand the flow of funds and the timing of cash drains or surpluses,” Bundy said, adding that financial statements with notes “give a level of confidence in the numbers” and speak to the effort that the borrower has gone to seek outside financial advice. “Knowing my borrower is interested in help and has been willing to invest in a good CPA for that help tells me that the borrower is not afraid to ask for advice and wants to use every tool to succeed,” he said.
The SBA will review a minimum of three years of business tax returns, three years of personal returns for each owner with an ownership stake of 20% or more (for personal guarantee requirements), current business and personal financial statements, and resumes on borrowers as well as key managers.
Zippwald suggested that for key positions that have not been filled, applicants include a thorough job description listing the skill set and experience of the candidate the company is seeking. “This will confirm for the lender that you have analyzed your needs and have determined the requirements of the position,” she said.
Business plans are critical, and Roberts added that a well-constructed business plan should include a clear statement of the total capital requirements of the business. It should “explain the source of the equity contribution for the business and the uses of the requested loan proceeds. The business plan should have supporting information such as a feasibility study, or demographic analysis and defined target markets with a marketing plan for how to achieve sales.”
The SBA requires collateral to fully secure a loan, to the extent that it is available. “If you own a home, you will likely be asked to pledge it,” Zippwald said. The SBA may also request a lien on business assets and may require life insurance on sole owners of a business. “Most loans made by banks are secured loans, and therefore approval may be contingent on a guarantor who is willing to offer collateral,” she said.
LANDING THE LOAN
Once you have gathered the information required for SBA loan processing, the next step is to determine the financial institutions that have an appetite for SBA loans. Some banks are more reluctant than others when it comes to SBA loans. Try to find out which banks underwrite the most SBA loans in your area and make a short list of potential lenders. Next, make an appointment with a commercial loan officer, and be sure to tell him or her that you would like to discuss an SBA loan.
Selling the bank on the viability of your proposal is the most important aspect of securing an SBA loan. Without the bank’s approval, there can be no SBA loan, so rehearse before the meeting.
The bank will have to ensure that all SBA conditions and required documents are in order, otherwise its SBA guarantee claim may be denied. If the bank believes that the extension of credit is not a sound decision, the process will go no further. This is why you need to develop a short list of SBA-friendly banks early in your research. Another financial institution may see the matter differently.
Once the bank approves the underwriting and ensures that all SBA requirements have been met, the package is sent to the SBA for review. If the SBA approves the bank’s request for a loan guarantee, the funds will be disbursed as soon as possible.
SHOULD YOU CHOOSE SBA?
The decision to pursue an SBA credit application is not necessarily an easy one. There are many factors to consider, including which programs to pursue, eligibility, fees, loan limits, collateral and other fundamental issues. An SBA loan could be beneficial to your business or a client’s business, and CPAs should be well-informed about how to analyze each program’s benefits and drawbacks. For specific information, see your commercial lender’s SBA group or a firm that provides SBA advisory services. In these times of uncertain credit, you may find that an SBA loan could make the difference between life or death for a business.
Approach SBA financing the way you would any other loan request. Be proactive with your banker and provide as much information as possible.
Educate your banker on the product or service for which you need funding. Discuss the market, the competition, the risks, as well as the mitigating factors involved in your business.
The SBA will want to see at least three years of business tax returns and personal returns for each owner with an ownership stake of 20% or more (for personal guarantee requirements), current business and personal financial statements, and resumes on borrowers as well as key managers.
Develop a short list of SBA-friendly banks early in your research. If one bank rejects an application, another financial institution may see the matter differently.
Ron Box ( email@example.com) is the CFO of Birmingham, Ala.-based Joe Money Machinery Co.
To comment on this article or to suggest an idea for another article, contact Kim Nilsen, editorial director, at firstname.lastname@example.org or 919-402-4048.
- “Act 2 for Business Tax Incentives,” March 2011, page 28
- “Highlights of the Small Business Stimulus Act,” Dec. 2010, page 26
Use journalofaccountancy.com to find past articles. In the search box, click “Open Advanced Search” and then search by title.
- Accountant’s Business Manual (#029418, with CD-ROM toolkit; and ABM-XX, online version)
- CPA Client—A Review of the Small Business Jobs Act of 2010 (#030015PDF)
- The Small Business Jobs Act of 2010: Tools, Tips, and Tactics (#091052HS, available as a CD-ROM)
Small Business Accounting Update (#734602)
AICPA National CFO Conference, May 19–20, Boston
For more information or to make a purchase or register, go to cpa2biz.com or call the Institute at 888-777-7077.
Small Business Accounting and Auditing Update (#SBAA)
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