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, maximum revenue amount or an alternative size standard to qualify as a small business.
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 firstname.lastname@example.org.
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You need operating cash to grow your business, but securing a traditional commercial loan hasn’t been easy, especially for small business owners. Bank loans to businesses grew 10 percent in 2011; however, commercial lending has not returned to pre-recession levels, largely because companies that experienced a decline in sales or profitability can’t meet today’s strict underwriting standards.
Fortunately, Small Business Administration (SBA) loans are a worthwhile financing option for small to mid-sized companies. An SBA loan typically offers longer terms and more competitive interest rates than other commercial loans and, best of all, bankers can be more lenient when considering your request because the government guarantees up to 75 percent of the loan amount.
“An SBA loan is a sensible option for businesses that experienced a decline in sales and profits during the recession,” says Santiago “Chico” Perez, SBA sales manager for California Bank & Trust. “Bankers can consider your financial projections, along with historical data, when evaluating your loan application.”
Smart Business spoke with Perez about the growth opportunities for small to mid-sized business through an SBA loan.
When should small business owners consider an SBA loan?
New ventures traditionally have a hard time securing working capital, but you may get $100,000 to $5 million through a government-backed SBA loan, as long as you’ve run a similar enterprise in the past and propose a viable business strategy. You can also use SBA funding to expand by purchasing another company or using the proceeds to procure equipment or inventory to fulfill a new contract. Businesses that use an SBA loan to pay off or restructure an existing mortgage or other business debt can free up cash for other investments, such as hiring or purchasing supplies.
How do SBA loans differ from traditional commercial loans?
Generally speaking, SBA loans can offer more favorable terms than traditional commercial loans. For example, you only need 10 percent down to purchase real estate and you don’t need to come up with a lot of cash because the SBA lets you roll the fees into the loan balance. SBA loans feature higher loan-to-value ratios, longer repayment periods and no balloon payments; consequently, companies often qualify for higher loan amounts because they can amortize the purchase of buildings over 25 years or equipment over the remaining economic life, and therefore need less cash flow to service the debt. In addition, owners can use the funds to buy raw materials, as well as finished goods or equipment, which gives manufacturers the flexibility to expand into new markets.
How does the SBA’s underwriting criteria differ from traditional commercial loans?
Bankers will review standard requirements such as financial statements and credit reports, but some criteria differ from traditional commercial loans.
*Projections. Bankers can consider future sales as well as historical data when evaluating your loan application, but be sure your projections are realistic and correlate with your current financials and forecasts. For example, earnings won’t automatically double if you purchase a larger facility or new equipment. Instead, explain how the equipment will boost the bottom line by lowering operating costs or how you’ll use the extra space to increase revenue by adding a new production line. Finally, substantiate your claims by furnishing copies of customer agreements and contracts.
* Resumes. Tout your management team’s industry experience and track record, particularly if you plan to start a new business.
* Ownership. Owners with more than a 20 percent stake in the business must submit signed personal financial statements and tax returns.
* Down payment. Lenders must determine the source of a borrower’s down payment, even if the funds have been deposited into an escrow account.
* Collateral. The need for collateral hinges on the loan purpose and program, so be sure to review the underwriting criteria at SBA.gov and specifically state the need and purpose for the funds in your proposal.
* Tax returns. Owners must supply three years of tax returns, financial statements and balance sheets instead of two to qualify for an SBA loan.
Does the SBA offer other support to small business owners?
The SBA provides myriad tools and support to help business owners create a loan proposal and navigate the underwriting process. Small Business Development Centers offer free assistance with financial, marketing, production and feasibility studies, and many centers engage local CPAs, retired executives and consultants to advise small business owners.
The SBA also provides mentorships, free counseling and business plan expertise through a nonprofit organization called SCORE, which helps business owners across the country with various aspects of their business.
What else can owners do to successfully navigate the SBA lending process?
Loan approval hinges on an accurate, thorough proposal, so it behooves you to take your time and seek expert advice because you only get one chance to make a great impression. Bankers want to hear the story behind your numbers, so be ready to explain how you overcame adversity during the recession and how you’ll use an SBA loan to take your business to the next level. Help your banker understand your customers and add value to your proposal by including links to your company’s website, LinkedIn page or Facebook page in your loan proposal. Finally, it may be possible to accelerate the process by selecting an approved Preferred Lender’s Program lender because they have the authority to approve your loan without submitting the entire package to the SBA.
Santiago “Chico” Perez is the SBA sales manager for California Bank & Trust. Reach him at email@example.com.
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Recent changes to the Small Business Administration’s 504 loan program have made it easier for small business owners to obtain loans. The definition of businesses that qualify has been expanded, and a reduction in the paperwork requirements has sped up the application process, says Ralph Barnett, executive vice president, SBA/Real Estate division, at Bridge Bank.
“When this was rolled out in February 2011, the SBA set criteria that weren’t very well received by the banks and the small business community,” says Barnett. “So it has modified the program to make it easier for small businesses to qualify for loans.”
Smart Business spoke with Barnett about how to take advantage of the SBA program to decrease the amount of your loan payments and increase your business’s cash flow.
How does the 504 loan program work?
The loans are used for real estate or major fixed asset transactions. One of the unique things about the program is that the bank makes the first positioned loan on the collateral and the SBA does a second, or junior, position on the same collateral. That encourages banks to lend, because there is a much lower advance rate on the property.
In the past, the program was only used for new acquisitions, but the SBA recognized that many small business owners also own their buildings, and the value of those buildings has fallen significantly as a result of the recent recession. This caused many lenders to ask borrowers to make significant payments to reduce their principle balances, and some lenders were even calling notes early or refusing to renew.
As a result, and as part of the Small Business Jobs Act, the SBA modified the 504 program to accommodate requests for refinances. This relieved much of the pressure felt by small business owners, and helped to minimize additional turmoil in the real estate market.
Who is eligible?
Some businesses may not be eligible for traditional bank financing, perhaps as a result of loan to value restrictions or insufficient financial performance. These businesses may, however, qualify under the SBA loan program. To understand the criteria, borrowers should seek advice from Preferred SBA Lenders — lenders who have been carefully selected by the SBA based on their performance history, including the demonstration of a high level of proficiency in processing and servicing SBA-guaranteed loans. In general, the SBA program enables borrows to receive up to $5 million in financing, and the lender can theoretically refinance projects as large as $20 million.
Most borrowers are seeking to refinance their real estate loans that may be about to adjust, or are reaching the point where a balloon payment is due. They’re seeking to take advantage of the favorable rate environment we’re in, and to improve their cash flows. Refinancing through the SBA program can provide a significant advantage for small businesses.
How has the program been modified?
The criteria have been expanded, and the application process has been streamlined. These changes are an incentive for banks to be active in lending to businesses hurt by the credit crunch, and for those businesses to continue to borrow and invest in their operations. In the past, the process was quite onerous, and could take six to eight months for a small business to obtain financing. Additionally, business owners felt burdened by some of the exhaustive requirements for information, so the SBA recently relaxed some of those requirements, making the process more efficient.
The SBA also recognized that, not only do small businesses need the ability to refinance their debt, but they also may need to draw out cash on that same property. We are starting to see businesses stabilizing and growing again, and they need to get working capital. So now the program allows for cash out, which it has never done before, to be used for future operational needs.
Finally, the SBA has adjusted loan ratios. Previously, there were cases in which the bank might make a million-dollar loan and the SBA would come in for $100,000 or $200,000. But it’s the SBA portion of the loan that has low market rates fixed for 20 years, which banks don’t offer. The SBA wanted to encourage banks to make loans and wanted small businesses to benefit. So they only thing it now requires is that the bank loan and the SBA loan be equal, essentially taking the loan and splitting it with the SBA. This modification is very advantageous to both the bank and the small business borrower, who gets access to a favorable below-market, 20-year fixed rate.
When the refinance program was first introduced in February, the level of applications remained low; conditions were still too restrictive. Since the modifications in October, however, the number of applications has increased tenfold. The door is now wide open for small businesses to take advantage of this beneficial government program.
What does the SBA look for in applicants?
Like all lenders, the SBA wants to lend to borrowers who can demonstrate their ability to repay the debt. To mitigate potential risk, the SBA and the bank will review the most recent 12-month repayment period to make sure the business has the ability to meet the terms and conditions of the note, and that it can make on-time payments.
That being said, the SBA also realizes that most small businesses have been impacted by the recession to some degree, and it has made some favorable adjustments to the program to accommodate for that impact. So even if the borrower’s business has had significant losses in the not-too-distant past, as long as the business has stabilized in terms of revenue and cash flow, and there is evidence that it can repay the loan, the bank can generally provide financing without requiring certain ratios for the past three years.
Ralph Barnett is executive vice president, SBA/Real Estate division, at Bridge Bank. Reach him at firstname.lastname@example.org or (408) 556-8334.