SBA Loans an Alternative Option for Businesses Seeking Funding

Tight credit availability and resulting cash shortages are common refrains from owners of companies throughout the country these days. With commercial banks' unwillingness or inability to provide timely financing, businesses are unable to meet current working capital needs because of "tapped-out" lines. This situation is often complicated by a lack of "qualified" collateral against which a bank may lend. In these circumstances, an SBA guaranteed loan may be a solution.

An SBA loan satisfies a bank's requirement to have both cash-flow and collateral (primary and secondary sources of repayment). Because the government partially guarantees the loan, the program shifts the lender's focus to cash flow strength over collateral coverage. Key to this program is the borrower's future prospects, management's industry experience and the owner's willingness to sign a personal guarantee. Borrowers with a strong backlog and diverse customer base, leading to stable to improving cash-flows, are great candidates for SBA loans. Strong cash flows may also permit the borrower to transfer a portion of their revolving credit line to a longer term loan for "permanent working capital," freeing up room under the line to take advantage of vendor discounts.

While most banks will amortize a term loan over a shorter time period, usually 3 years or less, banks supported with an SBA guarantee may be willing to go as long as 7-10 years. Borrowers, however, should be forewarned that in exchange for the SBA government guarantee, the owner will be expected to provide his/her personal guarantee, perhaps secured by the owner's personal assets including the personal residence.

Key points regarding SBA programs have been summarized below. Be sure to proceed with caution if you feel that an SBA program might be the solution to your credit log-jam; there are many nuances to the program. Banks that have the SBA's PLP status (Preferred Lender Program) are able to approve your loan package locally, possibly saving weeks in the underwriting process. Banks that do not have this special status utilize the GP (General Program) and must seek SBA national approval. The SBA program and loan approval process will also be especially document intensive. However, the SBA loan program may provide the credit / capital to grow your business or survive during this economic cycle.

What is an SBA Loan?
SBA = U.S. Small Business Administration

Multiple Programs – 7a, 504, SBA Express, Community Express

• Guaranteed loans and partnership loans
• Bank lends their money, SBA guarantees a portion of loan
• Designed as an incentive for banks to make more loans to small businesses, reduces the bank's risk
• Loans generally range from $5,000 - $2,000,000

Eligibility Size Standards (some exceptions exist)

• Manufacturing firms - up to 500 employees
• Service businesses - $1.5 to $24 million in annual sales 
• Wholesalers - up to 100 employees
• Retail businesses - $1.5 to $24 million in annual sales
• Contractors - up to $7.5 million in annual sales

Types of Businesses

• Business must be "for profit"
• NOT eligible:
• Co-ops
• Churches
• Gambling operations
• Businesses promoting religion
• Self storage facilities
• Apartments
• Investment property
• Businesses promoting prurient sexual material
• Pyramid schemes

Personal Resources Rule

If a financing package is $250,000 or less, the principals of a company cannot have liquid assets exceeding 2 times the financing package or $100,000, whichever is greater. For financing packages between $250,001- $500,000, they cannot have liquid assets exceeding 1.5 times the package size or $500,000, whichever is greater. For those transactions over $500,001, the principal cannot have liquid assets in excess of 1 time the package or $750,000. 

Other

Principals must be US citizens or hold a valid alien card. If a borrower has ever defaulted on any government type loan, including a student loan, they are not eligible. 

All individuals or corporations with 20% ownership in small business must provide unlimited guarantees.

Use of Funds

What problems might be solved with an SBA Loan?

• A company needs to refinance with repayment terms which are longer than a conventional loan to alleviate cash flow pressure.
• A company would have sufficient debt service capabilities with the longer repayment terms, but either the business has a leveraged balance sheet or inadequate collateral to qualify for a conventional loan.
• A line of credit is maxed out without additional availability. While most banks will amortize a term loan over a shorter time period, usually 3 years or less, banks supported with an SBA guarantee may be willing to go as long as 7-10 years. Personal assets could be used to secure the loan as well.
• Loans can be used for buy-outs of partners, management or even strategic acquisitions where cash flow is solid but collateral is weak.

Benefits to Borrowers

• A longer repayment term than a conventional loan; repayment is based on use of funds, not collateral
  o Real Estate – 25 years
  o Equipment – 7-10 years
  o Business Purchase – 10 years
  o Working Capital – 7 years
  o Inventory – 7 years
  
• Lower cash injection or equity requirements than a conventional loan
  o To purchase real estate and/or equipment
  o Purchase of existing business
  o Start ups
  
• Full loan commitment for life of loan, no balloons like regular business loans (less risk)
• Allows banks to make loans to riskier industries and younger companies or in under collateralized situations
• Costs less than equity

Lou Banach is a Managing Director of Schenck M&A Solutions and has 20 years of progressively responsible positions in business and financing of mid-market businesses, including multiple M&A assignments. As a former bank regional president for Ridgestone Bank, Lou led consumer and commercial personnel and business lines.

Schenck M&A Solutions provides a full range of merger-and-acquisition-related services including business sales, acquisition searches, valuations, due diligence services, cultural compatibility analyses, corporate turnarounds and assistance with recaps/refinancing and post-merger integration.

March 2009