Imagine you wanted to refinance equipment at your company. If you are given a conventional loan, the bank will likely offer a five-year loan term, depending on the type of equipment and useful life. But a U.S. Small Business Administration (SBA) loan could allow 10 years on that equipment, so your cash flow position would be improved with the longer term and amortization.
That’s just a small example of how SBA financing can benefit your organization’s cash flow equation by allowing for debt consolidation and refinance as well as financing working capital, says Romona Davis, vice president of SBA Commercial Lending at Ridgestone Bank.
“When you compare an SBA loan to a conventional loan, you’re going to find more attractive terms with an SBA loan,” she says.
If business owners capitalize on those more attractive terms, they can use the cash savings to assist with marketing, hiring, growing the business, buying inventory, etc.
Smart Business spoke with Davis about how SBA loans can improve business cash flow.
If your business is doing well, why should you still consider an SBA loan?
SBA loans are for small businesses, ranging from startups to well established for-profit corporations. The misconception is that SBA loans are for individuals with bad credit or companies experiencing financial challenges. In reality, SBA loans are for almost any small business.
They can be used to purchase or construct owner-occupied commercial real estate; buy out a business partner; purchase a business; obtain machinery and equipment; buy a franchise; refinance existing business debt; or provide for working capital.
The SBA assists with cash flow by offering longer terms and amortization, minimizing prepayment penalties and other protections. Typical SBA terms include up to 25 years for owner-occupied commercial real estate, and up to 10 years for machinery and equipment, a partner buy-out or business acquisition and working capital.
There is also no ‘balloon’ payment. The SBA 7(a) loan provides for a straight term and amortization; there’s no lump sum payment due during the term of the loan.
A borrower’s equity injection can be slightly less with an SBA loan, which is beneficial to some borrowers. Equity injection can range from zero to 30 percent, depending on the project purpose.
In addition, borrowers can utilize SBA loans when they have a collateral shortfall. If a business owner lacks sufficient collateral to cover a project or secure a loan, the SBA allows banks to finance the project once all available collateral has been pledged.
What do SBA loans require in terms of credit and cash flow analysis?
Banks will examine the 5Cs of credit — capacity to repay the loan, capital to invest in the project, conditions of the project, collateral associated with the project and character of the owners and/or personal guarantors. The SBA requires personal guarantees from those with at least 20 percent ownership in the borrowing entity.
Every bank is different in terms of its requirement for cash flow coverage, also known as debt service coverage. The SBA states that “each bank must conduct a financial analysis of repayment based on historical financial statements and/or tax returns and detailed projections.” Banks examine the EBITDA, along with required principal and interest payments on all business debt inclusive of new SBA loan proceeds.
The small business applicant’s debt service coverage ratio must be equal to or greater than 1.15 on a historical and projected cash flow basis. For startups, a three-year projection scenario with the first two years being month-to-month is required. Projections must demonstrate the ability to service the proposed debt.
If you struggle with managing your cash flow, what do you recommend?
Consult with a lender to determine if the existing debt is eligible for SBA refinance.
In order to qualify, the existing debt must be on unreasonable terms, cash flow savings must be at least 10 percent, and the debt being refinanced must be ‘business debt’ that would have been eligible for SBA financing.
Whether refinancing existing debt or obtaining a new loan, SBA 7(a) loans can improve working cash flow, allowing your business to reach its full potential.
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