For more than five decades, U.S. Small Business Administration loans have served as financial lifelines for American entrepreneurs. The SBA was created to foster free enterprise and to help sustain economic strength throughout all corners of a free market.
Traditionally, small business owners who have struggled to secure affordable lending have turned to the SBA for help. But the agency itself does not issue loans. Rather, it acts as a guarantor while working with thousands of private commercial institutions.
The SBA offers a series of loans geared toward helping small businesses. There are three major loan programs. Each provides entrepreneurs with different degrees of financing options and flexibility.
Business owners who can obtain reasonable financing may not be eligible for SBA-backed loans.
Is Your Business Eligible?
Most American small businesses meet the SBA’s eligibility requirements to obtain a loan. In general, the prospective loan recipient must have a for-profit enterprise doing business in the U.S., reasonable equity and have pursued alternative funding resources, including personal assets.
The SBA’s three major loan programs also have specific eligibility guidelines and requirements which are noted in each program’s details below.
There are certain businesses and applicants that are eligible but face specific restrictions or considerations. Among those are: franchises, recreational facilities and clubs, arms and agricultural businesses, fishing vessels and medical facilities such as hospitals, clinics and laboratories.
However, there are some business that are not eligible for an SBA loan. Those include: real estate investment firms, lenders, pyramid sales programs, gambling ventures and charitable, religious and otherwise non-profit outfits.
Types of SBA Loans
Basic 7 (a) Loan Program
This is the most common and basic loan small business owners are likely to encounter. Lending institutions that agree to structure their loans according to SBA requirements receive a guaranty on only a portion of the loan. Private lenders ultimately make and administer the loans.
The 7 (a) loan can be used for a host of business purposes, including equipment and real estate purchases, renovations and new construction, debt refinancing and working capital. For those seeking loans for working capital, maturity runs up to 10 years. For fixed assets, loan maturity is typically up to 25 years.
Eligibility requirements: Applicants must meet SBA size requirements, be for-profit, ensure that the financial need exists and demonstrate the capacity for repayment. Special programs within the 7 (a) program may carry with them additional eligibility requirements.
CDC/504 Loan Program
This program serves as a mechanism for long-term funding for small business owners. Entrepreneurs willing to tap into their equity can obtain long-term, fixed rate loans for major fixed assets, typically real estate or physical builidings.
These finance projects are often comprised of a collection of loans from several sources. Those might include a commercial lender; a loan from a Certified Development Company, a nonprofit corporation that facilitates economic development in a given geographical area; a junior lien covering nearly half the project’s cost; and at least 10 percent equity from the prospective borrower.
Loans under the 504 program come with greater restrictions in terms of how the capital can be utilized. In essence, small business owners can use the money only for fixed asset projects, including purchasing real estate, building new facilities or renovating existing structures and buying equipment.
The SBA recently expanded the 504 program through the American Recovery and Reinvestment Act of 2009. Qualified borrowers will be able to refinance their current SBA loan and roll over up to half of the total cost of the purchase or pending expansion.
For example, a small business proprietor with a $500,000 SBA 504 program loan could refinance to leverage up to $250,000 for equipment or an expansion. but for every $65,000 backed by the SBA, a borrower is required to create or retain a job. Business owners must also have kept debt payments current for at least a year.
Eligibility requirements: Prospective loan recipients cannot have a net worth beyond $8.5 million or an average net income greater than $3 million after taxes for the preceding two years.
Providing financing for:
• Real Estate
• Mix use properties
• Down Payment as low as 10%
• Refinancing of existing property
• Below market fixed rates
• Long term financing 10-20 years
This program offers minimal short-term loans to fledgling or growing small businesses. The SBA provides or guarantees a loan to a third-party intermediary, which are typically non-profit community lenders. These intermediaries then dole out loans to qualified entrepreneurs in amounts up to $35,000. The average loan is about $13,000.
Microloans run no longer than six years. Terms will vary depending upon the loan’s size, its intended use, and the requirements of a given intermediary. Interest rates are also subject to fluctuation.
These funds also come with restricted uses. Microloans can be used for working capital or to buy supplies, equipment, furniture and other physical needs. Microloan funding cannot be put toward repaying debts or buying real estate.
Eligibility requirements: Small business owners interested in learning about eligibility requirements for microloans should contact us for further information.
Providing financing for:
• Working capital
• Up to $50,000
• Fixed rate starting at 8%
• 5 year terms
• One on one business mentoring through the life of the loan
As with most other types of loans, lending institutions that work with the SBA will seek specific financial information when evaluating an application. The agency’s standards are a bit more flexible than others, but entrepreneurs still must have a solid profile to obtain an SBA loan.
Lenders will look for an array of documentation. Chief among them will be financial statements regarding the business and its owners, partners and officers. These will generally include; balance sheets for the last three years; cash flow projections; personal financial statements regarding assets, liabilities and previous tax returns; a breakdown of accounts receivable and payable; and any current financial information.
Applicants should also expect to produce a business profile; a specific breakdown of how the loan will be utilized; and an explanation of the collateral to be used to obtain the loan.
Lenders will also scrutinize an applicant’s credit and contributing factors. Those can be broken down into five distinct areas:
Lenders will scour debt-to-worth ratios, expected earning and projected profits. Businesses with little to no equity may scare off lending institutions, which generally see the gap as a harbinger of default. Entrepreneurs will be expected to prove the value of invested assets. Businesses with weak equity can still obtain SBA loans, provided they have solid credit indicators elsewhere. But as the SBA makes perfectly clear, low equity, high debt and baseless projections are a recipe for loan denial.
Cash outflow and management constitutes another major element. Small business owners will likely have to provide cash flow projections that detail the flow of capital and when expenses are paid. These projections typically cover the 12 months after the prospective loan is granted. The SBA recommends that new entrepreneurs document all the assumptions that go into creating revenue and expense estimates.
This is basically when a business has more assets than liabilities at a given time. It’s basically a way to examine a small business’ ability to pay current debts. Lenders will evaluate the nature and worth of assets on hand, as well as examine all liabilities due within a year.
Collateral is a requirement for all SBA loans. The agency accepts usable assets within the business and personal assets from beyond it. Any business owner with a 20 percent stake or greater must present a personal guarantee, as do other key management stakeholders. The SBA notes that assets financed with borrowed funds will ultimately collateralize the SBA loan. Lending institutions working with entrepreneurs who aim to use real estate as collateral will have to obtain third-party valuation on transactions valued at $50,000 and above. Much like equity investment, weak collateral itself will not generally disqualify a business from obtaining an SBA loan.
Lenders will closely examine the way capital and resources are managed. That includes scrutiny of an operation’s managers and leadership. Those evaluating a loan application may also rely on ratios derived from historical figures and financial statements, including debt-to worth, the rate that debt is paid upon becoming due and rate income is received after being earned. Lenders will also evaluate the subjective character of a particular applicant. Education, business experience and quality of references may all be considered.
After all this consideration, the final piece for entrepreneurs is crafting a formal written loan proposal. First impressions are crucial, both on paper and in person. There is no formula or exact science for writing a loan proposal. But the SBA does offer some suggestions when it comes time to pull it together. Some of those tips include:
• Start with a cover letter or executive summary that concisely explains the business, your background, the requested loan amount and other key information.
• Provide a separate, detailed description of your business that includes information on products and services, future operations, competition and customers.
• Submit a resume for each owner and key management member.
• Explain how the loan will be repaid, including sources and time estimates. Expect to submit cash flow information, budgets and other material financial documents.
• Include financial statements and information for the previous three fiscal years as well as current statements.
• If applicable, consider including copies of items such as leases, franchise agreements, letters of reference, contracts and copies of licenses.
For more detailed information on SBA loans and the loan application process, contact Coastal Commercial Group to learn how we can help you obtain an SBA Loan.