Your Tax Dollars At Work

If you have an interest in learning more about the U.S. Small Business Administration (SBA) and what it can do for your business, read on. In the next three issues, I will demystify the SBA and provide ideas regarding how to navigate the SBA and help your business take advantage of the myriad of services and programs offered. Remember, these are your tax dollars at work. The strength and power of the U.S. government stands behind you.

According to the SBA’s website, www.sba.gov, “While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second. Whether you’re starting a business or expanding one, sufficient ready capital is essential. But it is not enough to simply have sufficient financing; knowledge and planning are required to manage it well. These qualities ensure that entrepreneurs avoid common mistakes like securing the wrong type of financing, miscalculating the amount required, or underestimating the cost of borrowing money…”

Money, by itself, does not solve all cash flow problems. Business leaders, managers or owners must identify the root cause of cash flow problems. Typically, cash flow issues are not the real problem, but merely a symptom of underlying issues in a company. Examples of these issues include poor productivity, inadequate internal controls and procedures to manage the business in real time, inaccurate pricing policies and compensation programs that do not incentivize profitability.

A cash influx may put a short-term bandage on cash needs, but the hemorrhaging will continue unless the underlying causational issues are rectified. Do not let a cash windfall lead you into a false sense of security only to find the problem has been worsened by the cash influx. Make sure to borrow for the right reasons by fixing the underlying problems first so that new money is put toward growth and not into the proverbial black hole.

Here is another excerpt from the SBA Web site:

“The SBA is an independent agency of the Executive Branch of the Federal Government. It is charged with the responsibility of providing four primary areas of assistance to American Small Business. These are: Advocacy, Management, Procurement, and Financial Assistance. Financial assistance is delivered primarily through SBA’s Investment Programs, Business Loan Programs, Disaster Loan Programs, and Bonding for Contractors.”

Let’s focus on the SBA loan programs. In the articles to come, I will take an in-depth look at procurement and services for minorities—or what the SBA refers to as “special audiences.”

What we know about SbA’s loan programs

The SBA administers three separate, but equally important, loan programs. The SBA sets the guidelines for the loans while the SBA’s partners (lenders, community development organizations and microlending institutions) make the loans to small businesses. The SBA backs those loans with a guaranty that will eliminate some of the risk to the lending partners. The agency’s loan guaranty requirements and practices can change, however, as the government alters its fiscal policy and priorities to meet current economic conditions. The SBA offers numerous loan programs to assist small businesses. It is important to note, however, that the SBA is primarily a guarantor of loans made by private and other institutions.

PROGRAM: Basic 7(a) Loan Guaranty

The Basic 7(a) Loan Guaranty serves as the SBA’s primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. It is also the agency’s most flexible business loan program, since financing under this program can be guaranteed for a variety of general business purposes.

Loan proceeds can be used for most sound business purposes, including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets. 7(a) loans are the most basic and most used type loan of the SBA’s business loan programs. Its name comes from section 7(a) of the Small Business Act, which authorizes the agency to provide business loans to American small businesses.

All 7(a) loans are provided by lenders who are called participants because they participate with the SBA in the 7(a) program. Not all lenders choose to participate, but most American banks do. There are also some non-bank lenders who participate with the SBA in the 7(a) program, which expands the availability of lenders making loans under SBA guidelines.

7(a) loans are only available on a guaranty basis. This means they are provided by lenders who choose to structure their own loans by the SBA’s requirements and who apply and receive a guaranty from the SBA on a portion of this loan. The SBA does not fully guaranty 7(a) loans. The lender and the SBA share the risk that a borrower will not be able to repay the loan in full. The guaranty is a guaranty against payment default. It does not cover imprudent decisions by the lender or misrepresentation by the borrower. Under the guaranty concept, commercial lenders make and administer the loans.

The business applies to a lender for their financing. The lenders decide if they will make the loan internally or if the application has some weaknesses which, in their opinion, will require an SBA guaranty if the loan is to be made. The guaranty which the SBA provides is only available to the lender. It assures the lender that in the event the borrower does not repay their obligations and a payment default occurs, the government will reimburse the lender for its loss, up to the percentage of the SBA’s guaranty. Under this program, the borrower remains obligated for the full amount due.

All 7(a) loans that the SBA guaranty must meet 7(a) criteria. The business gets a loan from its lender with a 7(a) structure and the lender gets an SBA guaranty on a portion or percentage of this loan. Hence, the primary business loan assistance program available to small business from the SBA is called the 7(a) guaranty loan program.

A key concept of the 7(a) guaranty loan program is that the loan actually comes from a commercial lender, not the government. If the lender is not willing to provide the loan, even if they may be able to get an SBA guaranty, the agency cannot force the lender to change their mind. Neither can the SBA make the loan by itself because the agency does not have any money to lend. Therefore, it is paramount that all applicants positively approach the lender for a loan and that they know the lender’s criteria and requirements as well as those of the SBA. In order to obtain positive consideration for an SBA supported loan, the applicant must be both eligible and creditworthy.

What the SBA seeks in a loan application:

In order to get a 7(a) loan, the applicant must first be eligible. Repayment ability from the cash flow of the business is a primary consideration in the SBA loan decision process, but good character, management capability, collateral and owner’s equity contribution are also important considerations. All owners of 20 percent or more are required to personally guarantee SBA loans.

Eligibility criteria:

All applicants must be eligible to be considered for a 7(a) loan. The eligibility requirements are designed to be as broad as possible in order that this lending program can accommodate the most diverse variety of small business financing needs. All businesses that are considered for financing under the SBA’s 7(a) loan program must: meet SBA size standards, be for-profit, not already have the internal resources (business or personal) to provide the financing and be able to demonstrate repayment. Certain variations of the SBA’s 7(a) loan program may also require additional eligibility criteria. Special purpose programs will identify those additional criteria.

Eligibility factors for all 7(a) loans include: size, type of business, use of proceeds and the availability of funds from other sources.

Character considerations:

The SBA must determine if the principals of each applicant firm have historically shown the willingness and ability to pay their debts and whether they abided by the laws of their community. The agency must know if there are any factors which impact on these issues. Therefore, a “Statement of Personal History” is obtained from each principal.

In addition to credit and eligibility criteria, an applicant should be aware of the general types of terms and conditions they can expect if the SBA is involved in the financial assistance. The specific terms of SBA loans are negotiated between an applicant and the participating financial institution, subject to the requirements of the SBA. In general, the following provisions apply to all SBA 7(a) loans. However, certain loan programs or lender programs vary from these standards. These variations are indicated for each program.

Maximum loan amounts:

The SBA’s 7(a) Loan Program has a maximum loan amount of $2 million. The SBA’s maximum exposure is $1.5 million. Thus, if a business receives an SBA guaranteed loan for $2 million, the maximum guaranty to the lender will be $1.5 million or 75 percent. SBA Express loans still have a maximum guaranty set at 50 percent.

The SBA offers multiple variations of the basic 7(a) loan program to accommodate targeted needs.

PROGRAM: Microloan, a 7(m) Loan Program

A 7(m) Loan Program provides short-term loans of up to $35,000 to small businesses and not-for-profit childcare centers for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment. Proceeds cannot be used to pay existing debts or to purchase real estate. The SBA makes or guarantees a loan to an intermediary, who in turn makes the Microloan to the applicant. These organizations also provide management and technical assistance. The loans are not guaranteed by the SBA. The Microloan program is available in selected locations in most states.

The Microloan Program provides very small loans to start-up, newly established or growing small business concerns. Under this program, the SBA makes funds available to nonprofit community-based lenders (intermediaries) that in turn make loans to eligible borrowers in amounts up to a maximum of $35,000. The average loan size is about $13,000. Applications are submitted to the local intermediary, and all credit decisions are made on the local level.

Terms, interest rates and fees:

The maximum term allowed for a Microloan is six years. However, loan terms vary according to the size of the loan, the planned use of funds, the requirements of the intermediary lender and the needs of the small business borrower. The maximum loan amount is $35,000; however, the average loan amount is around $13,000. Interest rates vary, depending upon the intermediary lender and costs to the intermediary from the U.S. Treasury. Generally these rates will be between eight percent and 13 percent.

Collateral:

Each intermediary lender has its own lending and credit requirements. However, business owners contemplating application for a Microloan should be aware that intermediaries will generally require some type of collateral, and the personal guarantee of the business owner.

Technical assistance:

Each intermediary is required to provide business based training and technical assistance to its microborrowers. Individuals and small businesses applying for Microloan financing may be required to fulfill training and/or planning requirements before a loan application is considered.

How to apply:

Small businesses that are interested in applying for a Microloan should contact a microlender in their area.

Information for nonprofit entities seeking to become intermediary lenders applying to become an intermediary:

Organizations interested in becoming intermediaries should contact SBA for information on the application process and should review the regulations published in the Code of Federal Regulations. In order to participate in the program, applicants must meet three general criteria:

• An applicant must be organized as a nonprofit organization, quasi-governmental economic development corporation or an agency established by a Native American Tribal Government.
• An applicant must have made and serviced short-term fixed rate loans of not more than $35,000 to newly established or growing small businesses for at least one year.
• An applicant must have at least one year of experience providing technical assistance to its borrowers. Applications should contain supporting information describing.

The types of businesses assisted in the past and those the applicant intends to assist with Microloans.

The average size of the loans made in the past and the average size of intended Microloans.

The extent to which the applicant will make Microloans to small businesses in rural areas.

The geographic area in which the applicant intends to operate, including a description of the economic and demographic conditions existing in the intended area of operations.

The availability and cost of obtaining credit for small businesses in the area.

The applicant’s experience and qualifications in providing marketing, management and technical assistance to small businesses.

Any plan to use other technical assistance resources (such as counselors from the Service Corps of Retired Executives) to help Microloan borrowers.

PROGRAM: Loan Prequalification

A Loan Prequalification allows business applicants to have their loan applications for $250,000 or less analyzed and potentially sanctioned by the SBA before they are taken to lenders for consideration. The program focuses on the applicant’s character, credit, experience and reliability rather than assets. An SBA-designated intermediary works with the business owner to review and strengthen the loan application. The review is based on key financial ratios, credit and business history and the loan-request terms. The program is administered by the SBA’s Office of Field Operations and SBA district offices.

The Prequalification Loan program uses intermediary organizations to assist prospective borrowers in developing viable loan application packages and securing loans. This program targets low income borrowers, disabled business owners, new and emerging businesses, veterans, exporters, rural and specialized industries.

The job of the intermediary is to work with the applicant to make sure the business plan is complete and that the application is both eligible and has credit merit. If the intermediary is satisfied that the application has a chance for approval, it will send it to the SBA for processing. To find out whether there is a pre-qualification intermediary operating in your area, contact your local SBA office. Once the loan package is assembled, it is submitted to the SBA for expedited consideration. The SBA conducts a thorough analysis of the case, using the same time frame and degree of analysis that it uses when processing requests under the regular method of delivery process.

If the SBA decides the application is eligible and has sufficient credit merit to warrant approval, it will issue a commitment letter on behalf of the applicant. The commitment letter or pre-qualification letter, indicates the SBA’s willingness to guaranty a loan made by a lender under certain terms and conditions. The intermediary then helps the borrower locate a lender offering the most competitive rates. The applicant then takes the letter and its application documents to a lender for a decision. The maximum loan amount for this pilot program is $250,000. Interest rates, maturities, collateral policy and guaranty percentages all follow the standard 7(a) loan program.

The key is to understand what you need to prepare and present to increase the likelihood of getting an SBA loan approved and closed. In the next article, I will focus on procurement and the various programs the SBA has to help you get your fair share of the federal governments spend.