David R. Evanson
Where’s the Money, Winter, 1999
RESUME: SBA GUARANTEED BUSINESS LOANS
Definition or Explanation: Term loans from a bank or commercial lending institution of up to 10 years where the Small Business Administration (SBA) guarantees as much as 80% of the loan principal.
Appropriate For: Established small businesses capable of repaying a loan from cash flow, but where the principals may be looking for a longer term to reduce the monthly payments or have inadequate corporate or personal assets to collateralize the loan.
Supply: Vast. The SBA guarantees some $10 billion per year in loans. Said differently, because of SBA loan guarantees, more than $10 billion in loans annually are made by participating lenders.
Best Use: Purchasing equipment, financing the purchase of a business, and in certain instances, for working capital. The SBA guarantee can help borrowers overcome the problems of a weak loan application associated with weak collateral, or limited operating history.
Cost: Comparatively inexpensive. Maximum allowed interest rates generally range from highs of prime plus 4.75 percentage points to prime plus 2.75 percentage points though lenders can and often do charge less. These rates may be higher or lower than rates on non guaranteed loans. Even better, banks making SBA loans cannot charge fees for agreeing to make a loan (known as commitment fees) or prepayment fees, which means the effective rates on SBA loans may be, in some instances, superior to conventional loans.
Ease of Acquisition: Challenging. Although the SBA has created streamlined approaches to loan applications, conventional SBA guarantee procedures and protocols pose a significant documentation and administrative challenge for most borrowers.
Range of Funds Typically Available: The Small Business Administration will guarantee from $50,000 to $750,000 of loan principal.
Shop Talk: Many balance sheets have a liability item called “Current Portion of Long Term Debt.” If you have an SBA loan — or for that matter any loan — with, say, a five year term, the amount of the loan due in the coming year is the Current Portion of Lont Term Debt.
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THE SBA BRIDGES THE GAP . . . .
The demands of a term loan are challenging for any business. The old banking adage, that they only lend money when you donzzt need it is an old banking adage, largely because itzzs true. It should not come as any surprise then that term loans are particularly challenging for small businesses. In fact, in some ways, term loans are completely at odds with the rhythms and general mayhem of a small business.
To understand why this is so, consider two of the three primary criteria banks use, cash flow and collateral, to evaluate loan proposals. The third, incidentally, is the character of the borrower, i.e., do they exhibit the kind of behavior, past and present, which is consistent with the repayment of debts. While the character test is easy to pass, cash flow and collateral are more challenging for small businesses.
Consider the issue of collateral. That is, assets of value which can stand behind the loan, and if necessary, be liquidated to pay it off. Many small businesses cannot collateralize a loan because they are service businesses without much in the way of tangible assets. Compounding the problem, many small business owners are cash poor; whatever assets they have are often sunk into the business, often making their personal guarantee inadequate.
Itzzs for these reasons that an SBA loan guarantee can be effective according to Michael Gallagher, a vice president and manager of market development with Wells Fargo Bank, the west coast behemoth with $100 billion [italicize billion] in assets. “By providing lenders with a government guarantee on as much as 80% of the principal, it bridges the gap between what is likely to be a borrowers available collateral and the collateral a lender would require to make such a loan.”
. . . AND LOWERS THE CASH FLOW HURDLE
According to Gallagher, the other way that SBA loan guarantees can help is by extending the term of the loan. SBA guaranteed business loans (as opposed to real estate loans) typically have seven year terms and can have 10 year terms in many cases. “For most term loans which are not guaranteed, the longest a bank will usually go is five years,” he says.
The cash flow impact of extending the term of a loan can be compelling. For instance, a 9%, $300,000 loan paid monthly over five years will cost $6,228 per month. But this same loan amortized over 10 years, will cost just $3,801 per month, $2,427 less. For the small business owner with uncertain, or variable cash flow, this is a material difference.
SIDEBAR: SBA GUARANTEED LOAN FLOWCHART
1. Borrower makes a loan application to an SBA lender. Lender analyzes loan application and approves it subject to an SBA guarantee.
2. Lender submits application and credit analysis to SBA, along with an application completed by the borrower.
3. SBA processes the guarantee request, and if approved, issues a guarantee on the 75% of the loan proceeds (80% if the loan is less than $100,000).
4. Borrower pledges business assets as collateral to SBA and, provides SBA with a personal guarantee. If the loan is under collaterlized, liens on personal assets, such as the borrowerzzs personal residence, will be required.
5. Lender approves and authorizes loan, disburses funds to company.
A WORD ON POSTURE
The sidebar above indicates a step in the sequence which sometimes surprises would-be borrowers: A pledge of the businesseszz assets and a personal guarantee with liens on personal property. Thatzzs right. The principals of the business guarantee repayment to the Small Business Administration in the event the loan goes south and the agency has to pay off the portion of the loan which it guaranteed.
Donzzt Forget: SBA loan guarantees are designed to make loans easier to get, not easier to pay for.
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Whatzzs going on here? After all, one of the primary reasons to seek out an SBA guarantee in the first place, is to overcome inadequate collateral. In fact, if the SBA maintained the same rarefied collateral standards as most lenders, there would not be any compelling reason to seek out an SBA guarantee to begin with.
But according to Wells Fargozzs Gallagher, the SBA takes more risk on a personal guarantee than most lenderzzs do. “In truth,” says Gallagher, “the SBA will tend not to turn down guarantees where insufficient collateral is the only unfavorable factor in the loan application.”
But Gallagherzzs quote gets right at the heart of the matter. Small Business Administration loan guarantees exist to facilitate the disbursement of a loan, not to protect the assets of a business and its owners, in the event the loan runs into trouble. The guarantees and liens then serve as important role in the eyes of the SBA. Specifically, they motivate the borrower to perform financially and repay the loan.
Donzzt Forget: An SBA loan guarantee will likely require you to pledge all of your business and personal assets. In addition, if things go poorly and the loan goes south, there will be some real discomfort in your personal and business finances if you as the borrower must liquidate assets which were pledged to the SBA.
SIDEBAR: OVER HERE . . . OVER THERE
If you are planning to export, you should look into the SBAzzs Export Working Capital Program. This financing facility allows up to an 80 percent guarantee on private-sector loans of up to $750,000 for working capital. Loan maturities are typically 12 months, and include two 12 month renewal options. Loans can be for single or multiple export sales and can be used for pre shipment exposure coverage. They cannot however be used to purchase fixed assets.
Another source of export financing is the Export-Import Bank of the United States. Like the SBA the Ex-Im Bank offers working capital guarantees to small and medium sized businesses to cover 90% of the principal and interest on commercial loans. In addition the Ex-Im Bank also offers export-relate insurance services that can protect entrepreneurs against foreign buyers who wonzzt pay. For more information about the Ex-Im bank, or to find regional Ex-Im Bank offices call 202-565-3946.
A Good Deal: Not all banks that make SBA loans are created equal. Some are good and some are not so good. Therefore, choose your SBA lender carefully. Whatzzs the best criteria to go by? Experience. Generally speaking the more SBA loan a lender has made the better they are at it.
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HOW TO FIND AN SBA LENDER
While most banks, as well as some select commercial finance companies, offer SBA loans, there are two specialized categories worth knowing about. These are Certified Lenders and Preferred Lenders, both of which have entered into contractual relationships with the SBA and officially participate in the Certified Lender/Preferred Lender programs (CLP/PLP). These lender programs were designed to provide better response to borrowers, and accomplish this goal by placing additional responsibilities on the lenders for analysis, structuring, approval, servicing and liquidation of loans, within SBA guidelines.
A Good Deal: Time is money, and so-called certified or preferred SBA lenders, because of their relationship with the SBA, can turn around loans much faster than other lenders.
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There are about 850 lenders that qualify for the SBAzz Certified Lender Program, having met certain criteria, the most important of which, from the borrowerzzs perspective, is extensive experience in SBA loan guarantee processing. Certified lenders account for about 9% of all SBA business loan guarantees. Since the Certified bank does a lot of the SBAzzs work, , the agency offers a turnaround times of three business days for processing the application.
There are approximately 500 lenders which meet Preferred Lender standards. This group of lenders processes approximately 30% of SBA loans. Preferred lenders have full lending authority and as a result are capable of offering a one day turnaround on completed loan applications.
Shop Talk. Many loan rates are pegged to the so-called “prime rate”. But what is this rate? Itzzs the interest large “money center” banks charge to their best, most credit worthy customers. Most small businesses offer banks higher risks than larger customer, and as a result are often charged interest rates of “prime plus three percent.”
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If you are seeking an SBA loan, your best bet is to work with a Certified or Preferred lender. The SBA guarantee process is tricky at best, and you want a lender who has been through it more than once. To find Certified or Preferred lenders, visit the SBA website at www.sba.gov. Click on “Listings & Directories” in the reading room, or click on “Local SBA Resources.” As always you can call your local SBA office for guidance.
CHART: SBA BUSINESS LOANS AT A GLANCE
7(a) Business 7(a)
Loan LowDoc Loan FA$TRAK Loans
Use Equipment Equipment Equipment
Working Capital Working Capital Working Capital
Buy existing bus. Buy existing bus.
Term or Line of Credit Term Term Both
Amount $750,000 $80,000 $50,000
Principal Guaranteed 80% of loans under 80% 80%
$100,000; 75% of
loans more than
$100,000 to $1 million
Term Up to 10 years Up to 10 years 7-10 years, term loans
5 year line of credit
Rates Adjustable rate only Adj. rate only Adj. rate only
Maximum of P* +2.75% Maximum of: Maximum of:
for loans of $25,000 for loans of $25,000
or less or less
* P = Prime Rate P + 3.75% P + 3.75%
for loans between for loans between
$25,000 and $50,000 $25,000 and $50,000
for loans between for loans between
$50,000 and $100,000 $50,000 and $100,000
Speed of SBA
Processing Up to 6 weeks Up to 3 weeks Within 3 days
Source: Wells Fargo Bank
ONEROUS BUT UNAVOIDABLE FEATURES OF AN SBA LOAN
Under the heading that there is no such thing as a free lunch, much less a free loan guarantee, the SBA loan application process offers would-be borrowers a host of challenges with respect to documentation and administration. Gregg Mitchell, vice president of SBA lending with Wells Fargo, which loans $100 million per year to small businesses under various SBA programs, has seen literally thousands of SBA loan deals. Some aspects of the application process which tend to give borrowers, literally, a run for their money include the following.
– Controlled disbursements. When you get a 7(a) business loan, you donzzt get a check to deposit in your account and spend as your please. No, no. The SBA lender makes out checks to certain vendors which were described in the loan application. “Where this can get sticky,” says Mitchell, is that when you start out applying for a loan, you may believe you will spend say $50,000 with one vendor for a certain piece of equipment. But when the time for the loan gets closer, that amount may have gone up or down.” If the amount changes too much, the application may have to be re-approved. At the very least it must get changed, which of course chews up valuable time.
– Hazard Insurance. To get an SBA loan, you must get your insurance company to provide an endorsement to the lender, that in the event of a disaster, such as a fire, or tornado, or theft, the proceeds from the policy go to the lender not the borrower. If you have the right insurances, the endorsement is almost a no-brainer, but simply takes time and effort. If you donzzt have the right insurance, youzzll find yourself shopping for it before the loan application process is over.
– Additional Disclosures. Mitchell says there is a host of disclosures and documentation which is generally not necessary with conventional loans. Résumés, statements of personal history, disclosures on arrests and convictions, interim financial statements all add the mounting paperwork associated with the loan guarantee application.
– Landlord Consents. If you rent or lease the property upon which your business resides, there is another hurdle you must leap over on your way to an SBA loan guarantee. Specifically, a landlord consent is where the landlord provides the lender with the right to enter the premises and retrieve the business collateral in the event of a default. Unfortunately, landlords donzzt always willingly sign these consents, and sometimes they wonzzt sign them at all. Their reluctance stems from a belief that if a tenant is going to default on a loan, then they might also default on a lease. And if thatzzs the case, then the landlord doesnzzt want the bank emptying out the factory or office of the only valuable assets which may be left. “The landlord consent can be a tough issue,” say Mitchell. “Izzve seen it kill some weaker deals.”
– Other Insurances. If a loan is under-collateralized, meaning that after all business and personal assets are pledged, there is still a gap between the loan principal and the assets behind it, then in all likelihood the SBA will require life insurance on the principals of the business. Wells Fargozzs Mitchell says that for young entrepreneurs term insurance is cheap and easily obtained. But for older entrepreneurs the premiums can be steep, sometimes in excess of $12,000 per year. If a business owner is elderly, they may not even be able to buy life insurance. And cost aside, life insurance can take weeks, and in some case months to put in place, further slowing down the loan process.
Also on the insurance front is flood insurance, which is required for any business which happens to reside in a flood plain. No big deal you say. But lenders must consult a geological database, and if it says the company is in a flood plain, itzzs in a flood plain. “Many entrepreneurs are surprised to learn their business is located in a flood plain,” says Mitchell. And he adds they are also surprised at how difficult to get and expensive flood insurance can be.
– Liens. Mitchell says the SBA will not turn down a guarantee on a loan just because it is under-collateralized. But he says they will take a firm stance on ensuring all the borrowerzzs business and personal assets are backing the loan. And with regard to these assets, the agency will often go far beyond guarantees and put a lien on business and personal assets. The upshot of this posture is that, if the SBA puts a deed of trust against your home, and you default on your loan, and eventually file for bankruptcy, the home could be at significant risk.
Gallagher, who acknowledges the difficulties the above terms and conditions can place on borrowers, remains pragmatic about them. “It is politically necessary that when the government becomes involved in lending that there are as many safety nets in place as possible. Without them, the government would get a PR black eye any time something went wrong.” What would happen if, he says, a slew of SBA backed businesses got wiped out by floods, and none of them had flood insurance? “These requirements,” he says, “are simply a necessary part of the process.
SIDEBAR: FASTER TRACK . . . SMALLER GUARANTEE
Certain lenders in the SBAzzs loan guarantee program also make so-called zzFA$TRAKzz loans. The application for a FA$TRAK is as streamlined as possible according to Wells Fargozzs Gallagher. In fact, he says there is no SBA application whatsoever. “With FA$TRAK,” he says, “lenders use their own systems for analysis, approval and disbursement, and do not have to meet all the application requirements of a conventional 7 (a) loan.” For a description of some of the more onerous of the requirements that pertain to standard 7 (a) and LowDoc loans, see the sidebar above.
According to Gallagher, “If you are seeking an SBA loan, and need $100,000 or less, you can save a lot of aggravation by going with a FA$TRAK loan.” And he adds, if your lender can make FA$TRAK loans, but is offering the 7 (a), “push for the FA$TRAK. Youzzll be happy you did.”
One of the differences between a FA$TRAK and regular SBA-guaranteed loan is that FA$TRAK can be used for lines of credit as well as term loans. “Many companies,” says Gallagher, “would prefer to access working capital by drawing on it as needed rather than getting locked into a term loan with regular payments.”
Another difference is the guarantee percentage. For conventional loans, the SBA will guarantee 75% to 80% of the loan principal. For FA$TRAK, the guarantee extends to just 50% of loans of $100,000 or less.
For companies seeking a loan, the percentage of guarantee doesnzzt matter per se, except that the lower the guaranteed portion, the stronger the deal needs to be to get a nod from the lender. Maximum rates on FA$TRAK loans are the same as for 7 (a) loans — from prime plus 4.75 percentage points, to prime plus 2.75 percentage points.
Taking Action: To get a FA$TRAK loan, you must go to a selected Preferred lender. These selected Preferred lenders can be found at the “Local Resources” section of www.sba.com. However, since not all Preferred lenders are making FA$TRAK loans, it may be necessary to call more than one lending institution.
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SBA GUARANTEE FEES
Although SBA lenders are not allowed to charge application fees, points or prepayment penalties, there are guarantee fees to contend with. In actuality, these are charged to lenders by the SBA, and lenders almost always pass these fees onto the customer, i.e. you the borrower. If you get an SBA guaranteed loan here is what you might be facing in terms of guarantee fees.
• Loans with maturities of one year or less carry a guarantee fee of 0.25% of the amount guaranteed. On a $200,000 guarantee, this works out to $500. Peanuts.
• Loans in excess of $80,000 with maturities of more than one year carry a fee of 3% for the first $250,000 guaranteed, 3.5% of the next $250,000 guaranteed, and 3.875% for any amount in excess of $500,000.
Loan Amount % Guaranteed Guarantee Amount
$800,000 75% $600,000
1st $250,000 3.00% $7,500
2nd $250,000 3.50% $8,750
Remaining $100,000 3.875% $3,875
Total Guarantee Fee: $20,125
Itzzs important to note fees generally donzzt come out of your pocket, but out of the loan proceeds instead. Though this is an easy way to go, itzzs important to understand that guarantee fees have the net effect of jacking up the effective rate of the loan.
How is this so?
Assume you borrow $800,000 for five years at 9%. Your monthly payment on the loan will be $16,608. However, now assume that you pay a guarantee fee of $20,125, which is taken out of the loan proceeds.
In truth then you only get $779,875 ($800,000 – $20,125). But you are making monthly payments on $800,000. The net result is that you are not really paying 9% interest. That is simply the contractually agreed upon rate. The effective [italicize effective] rate, which you as the borrower would be paying is almost 10.125%. This effective interest rate is almost 14% higher [italicize higher] that the stated interest rate.
SIDEBAR: LESS IS MORE: LowDoc LOANS
Another streamlined approach to SBA loans are so called LowDoc loans. LowDoc refers to low documentation loans. Rather than the voluminous and challenging 7 (a) application, the LowDoc loan application comes down to a simple one page affair.
For loans in excess, of $50,000 though, borrowers will have to supply good old Schedule C of their federal income tax return, and or their business returns. In addition, LowDoc loans have a ceiling of $100,000, and borrowers are prevented from paying off certain kinds of debts with the proceeds from a LowDoc loan. Rates on LowDoc loans are variable and range from a high of prime plus 4.75 percentage points, to a low of prime plus 2.75 percentage points.
While the LowDoc can overcome some of the headaches associated with the application process it does nothing to alleviate some of the more restrictive terms associated with conventional SBA loans, which include controlled disbursements, flood insurance, life insurance, and hazard insurance, among other items.
Overall, according to Gallagher, the LowDoc program provides some solutions for entrepreneurs, but that where possible, FA$TRAK loans represent a better option.
All lenders can offer LowDoc loans, although not all may choose to do so. Best bet for finding one that will: call your local SBA office and ask for the names of institutions, as well as the names of bankers themselves making LowDoc loans. When you call, ask for a Public Information Officer.