Finding the necessary financing to thrive — or just survive — can be difficult for small businesses. But there are resources available to help startups and entrepreneurs compete in this market.
“SBA loans are designed for borrowers that might not qualify for conventional financing due to a number of different reasons,” says Romona J. Davis, Vice President of SBA lending with FirstMerit Bank.
Smart Business spoke with Davis about how to determine whether an SBA loan could help your business, and how to get started with the process.
What are the differences between SBA loans and conventional loans?
The main difference is that SBA loans are backed by the United States government, which provides a guarantee to the bank. SBA loans are for borrowers that might not qualify for conventional financing due to a variety of reasons, such as:
- Insufficient collateral
- A startup business or one that’s only been in existence for a short period of time
- The company is looking for a longer term on its owner-occupied commercial real estate purchase
- The borrower is in a ‘high-risk’ industry
- The borrower only wants to inject a minimum down payment
- Impending or current ownership changes with the business
- Inconsistent financial performance over the past few years
How does a lender determine if an industry is high risk?
It varies by bank. Most banks consider the restaurant industry as one that has a lot of risk associated with it. Also, when the economy changed and building contractors were negatively impacted, they became high risk.
However, being part of a high-risk industry doesn’t mean a conventional loan is impossible.
What can SBA loans be used for?
SBA loans can be used to:
- Purchase owner-occupied commercial real estate
- Buy out a business partner
- Buy a business
- Purchase machinery and equipment
- Buy a franchise
- Construct a building (the business must occupy 60 percent of the space)
- Cover working capital needs
- Refinance existing business debt
What types of businesses are eligible for SBA loans?
To qualify for SBA financing, the entity must be designated ‘for-profit.’ In addition, the business must meet certain SBA size standards, demonstrate good character, have a positive payment history on previous federal debt (no prior defaults on federal debt), possess U.S. or Legal Permanent Resident status, and show reasonable expectation of repayment.
What are the required size standards?
The SBA has developed size standards for different types of industries. Companies must meet either a maximum number of employees or maximum revenue amount to qualify as a small business. For example, in the manufacturing industry a small business must have fewer than 500 employees to be considered for an SBA loan. The bank will check to make sure the company is within standards. Some industries have a revenue amount; some have a required number of employees. Rarely do we find a company that doesn’t fit, but occasionally a company is too big to be considered a small business. Also, the SBA loan limit is $5 million per borrower.
How is ‘good character’ determined?
First, the SBA looks at the company’s credit, tax liens and any prior delinquencies with the government.
Also, the SBA always wants to know if a borrower has any criminal background, has been under indictment, is currently on probation, has ever been on probation, or has ever been charged with or arrested for any criminal offense, other than a minor motor vehicle violation.
The two ways to assess character, from the SBA’s perspective, are through personal credit and personal background.
Why might a business opt for an SBA loan instead of a conventional loan?
Businesses might opt for an SBA loan versus a conventional loan if they:
- Want a longer term on their owner-occupied commercial real estate or equipment loan
- Want a straight term and amortization versus a balloon note
- Prefer a lower down payment on their transaction
- Have a collateral shortfall
- Want to consolidate business debt into one loan that could offer a longer repayment period
- Want to buy out their business partner with a minimum equity injection
- Want to purchase a business but there’s insufficient collateral
- Desire cash flow savings due to a longer term and amortization
How can businesses get started with the loan process?
If a business is interested in an SBA loan, the first step is to contact a bank that participates in the SBA Program. The banker will need to make certain that the company is eligible as indicated above. Assuming the business is eligible, the borrower would need to provide a financing package to the bank for SBA consideration.
Disclosure: All opinions expressed in this article are that of the authors or sources and do not necessarily reflect the views of FirstMerit Bank or FirstMerit Corp.
Romona J. Davis is Vice President of SBA lending for FirstMerit Bank. Reach her at (330) 996-6242 or [email protected]