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Chapter 4

SBA Loans

For years, Leslie had dreamed of opening her own one-stop event shop that combined her exceptional baking skills, her background in design, and her experience as a florist. Having worked part-time for years for a well-established florist in Austin, Texas, Leslie had aspirations of taking over the shop when the owners retired, which they’d announced would be soon.

Leslie, was anxious to get started. But then, the flower shop owners told her that they had decided not to retire after all. It was time for Leslie to take matters into her own hands.

The business plan she’d been tinkering with for years became her sole focus. Despite being in the midst of the worst economic downturn since The Great Depression, Leslie worked feverishly with her local Small Business Development Center to formulate a comprehensive, realistic, thorough business plan for the flower shop.

“The flower shop seemed like the hardest hurdle,” Leslie says. “Getting a retail base and a clientele so that it can sustain itself seemed like the best way to start, and then down the road I could expand to include the culinary aspect. You have your first-year goals, then your five-year, your ten-year … but this was the best place to start.”

That same month, Leslie’s counselor at the Small Business Development Center advised her to apply for an SBA-backed loan, as part of a program that was set to expire at the end of April. The center had worked with a bank in Florida in the past, and had been very helpful with their advisees; Leslie’s plan had a shot, and it was worth applying.

Leslie filled out the 7-page application, and submitted her business plan, along with a lot of other documentation, to the bank, and by the end of March, she learned that she’d been approved for a $50,000, SBA-backed Community Express Loan, as part of the bank’s Express Capital Loan program.

Leslie still needed to come up with the 10 percent down payment on her downtown Austin location—the loan wouldn’t cover this. Fortunately, Leslie had also entered a business plan competition, and she learned in April that her plan had taken third prize. Her winnings enabled her to make the down payment.

Leslie opened her shop in the summer, and began making payments to the bank just one month after receiving her disbursement. “The loan was my working capital. I was able to get the bills paid and buy some inventory,” she says, explaining that she had made a practice of collecting deep-discounted inventory over the years, which really kept her initial costs down. “Being able to have extra capital in the first six months, when I was still building a client base, was really important.”

Within her first nine months, her business had hired three part-timers, took on an intern/business assistant, been ranked by Austin’s local alternative weekly paper among the top three florists in town on its “Best of Austin” list, and broke even financially. “I’m still not taking a salary yet,” Leslie says a year and a half after opening her doors, “but the business is now holding its own. We did $250,000 in our first year.”

Leslie says that although her SBA-backed loan was relatively small in comparison to some other business loans out there, without it her dream might not have come true—at least, not so quickly.

Leslie is among a growing number of Americans who have been able to start or grow their businesses thanks to the Small Business Administration, which guarantees privately funded loans through several loan programs that target a variety of businesses. The SBA now facilitates the lending of tens of billions of dollars every year. And for many businesses, these loans mean the difference between being in business and closing their doors (or never opening them in the first place).

The SBA’s Loan Programs

Businesses usually seek capital for one of two reasons: 1) They’re in survival mode, trying to start up or simply stay in business, or 2) They’re looking to expand.

Businesses in survival mode are looking for subsistence funding just to stay alive. In the case of start-ups, they need money to secure locations, purchase materials and inventory, develop marketing materials, and pay the bills so they can keep their lights on. For other businesses that may have already been in existence, they’re in survival mode because of any number of factors—an economic downturn, construction blocking their entrance, or the emergence of a new competitor, for example.

On the other hand, expansion-mode businesses have a track record of success. They’re profitable and need to grow to increase profits and meet consumer demand. Banks like expansion-mode businesses.

But it’s often survival-mode businesses, particularly in a tough economic times, that are seeking loans. Perhaps they’ve exhausted all their families’ and friends’ resources, have maxed out their credit cards, or simply can’t afford to compete without an injection of funds.

Meanwhile, most commercial lending banks see survival-mode businesses as a great risk; they often prefer lending to businesses that are expanding, who can prove their accomplishments and have considerable assets that ensure they can pay back their loans. And this simply isn’t possible for many small businesses. Here’s where the SBA steps in.

First, it’s important to note that the SBA itself actually doesn’t do any lending. Rather, it sets guidelines for loans made by traditional lenders that it partners with, then acts as a guarantor for those loans made to business owners who might have trouble qualifying for traditional bank loans. The guaranty provided by the SBA on a large percentage of the loan ensures the bank that the majority of the loan will be paid back.

To get an SBA loan, a business owner goes to one of the SBA’s partner banks or lending institutions and applies for the loan directly through this lender. If approved, the loan is eligible for an SBA guaranty, which is a percentage that represents the portion of the loan that the SBA will repay the bank if the business owner defaults on the loan.

The SBA guaranty, at the time of this writing, covers up to 85 percent of the loan amount, which is a considerably lower-risk proposition for banks than loaning to unproven businesses.

The Guaranteed Loan Programs offered by the SBA vary depending on your needs and the size of your business. One of the loan programs is:

Basic 7(a) Loan Program

The 7(a) loan, according to the SBA’s website, provides eligible borrowers with up to $5 million in capital for “starting, acquiring and expanding a small business. This type of loan is the most basic and the most used within SBA’s business loan programs.” All owners of a business with at least a 20 percent stake in ownership must personally guarantee the loan.

A 7(a) loan may be used to:

• Purchase land or buildings, including conversion of existing facilities or new construction

• Purchase equipment, supplies, furniture, and materials

• Maintain short- and long-term working capital for such things as payments on accounts receivable, seasonal financing, contract performance, construction financing, or export production

• Refinance certain business debt with unreasonable terms or conditions

• Purchase an existing business

Borrowers may not use a 7(a) loan to effect a change of ownership or practice that would not benefit the business, pay delinquent taxes or other funds held in trust or escrow, refinance existing debt that would create a loss for the lender, or for any business purpose that the lender may find to be unsound.

The eligibility criteria for 7(a) loans are the broadest of all the SBA’s guarantee programs. This program targets small businesses, which the SBA defines as “one that is independently owned and operated, is organized for profit, and is not dominant in its field.” In general, depending on the business type the business’ annual receipts may have a cap at between $2.5 to $21.5 million. And despite the loan being designed to help start-up businesses, most lenders won’t make this loan to businesses that don’t have two or three years’ worth of financial statements and an owner with equity in the business.

Under the umbrella of the 7(a) program are some specialty loan programs:

SBAExpress: Aimed at expediting the loan application process and getting loans of up to $350,000 quickly into entrepreneurs’ hands, this program targets business owners with a good borrowing track record. It involves a speedy response time of 36 hours and, often, a low interest rate. The downside of this, however, is that the expedited processing time comes with greater risk and, therefore, a lower guarantee of just 50 percent.

Small Loan Advantage: The Advantage programs also involve streamlined application processes. Guaranteeing 85 percent of loans up to $250,000 and 75 percent for amounts greater, the SBA offers this loan to larger businesses looking to borrow small amounts, which benefits businesses in underserved areas. The application for this loan is only two pages, and most of them can be approved in minutes with electronic submission.

Community Advantage: This is another Advantage program that targets underserved communities. This three-year pilot program begun in January 2015 is designed to increase the number of lenders that can make SBA 7(a) loans to distressed and underserved communities. With a maximum loan size of $250,000, this loan features streamlined paperwork, a two-page application, and an approval process of ten days or less. The program targets communities, such as minorities, women, veterans, and businesses in rural or low-income areas. Borrowers are encouraged, as part of the application process, to work with advisors on developing business plans.

CDC/504 Loan Program:

The SBA’s website says that as of January 2015, this loan program had provided $50 billion in loans and created more than two million jobs. It’s designed for small business owners looking to purchase assets or finance real estate for expansion. This program may be particularly important for businesses, for example, in which heavy machinery and rapidly advancing technology play a key role; without an injection of loan monies for such acquisitions, a business may simply be unable to compete in its field.

These loans are provided through Certified Development Companies, or CDCs, which are nonprofit corporations that promote community economic development in specific geographic areas across the country. (CDCs may be accessed through your local SBA office. You’ll find a list of SBA offices at http://www.sba.gov/about-offices-list/2.)

In a 504 loan, the SBA guarantees a CDC-provided loan of up to 40 percent of the total project cost; a participating lender kicks in 50 percent, and the borrower covers the last 10 percent. The 504 loan comes with long amortization periods, fixed interest rates, and no balloon payments. There is no maximum project size, but the maximum loan amount is $5 million.

Here is how it benefits the community and the economy to make these loans available: The program stipulates that unless your business meets specific community development standards for underserved communities as set forth by the CDC, it must either create or retain a job for each $65,000 guaranteed by the SBA (or $100,000 for small manufacturers.)

A 504 loan may be used to:

• Purchase or improve existing buildings

• Make improvements to the land

• Modernize, upgrade, retrofit, or convert existing facilities

• Purchase new machinery

A 504 loan is, of course, not accessible for start-ups. It may not be used for working capital, inventory, to refinance such debt, or to consolidate or pay off debt.

Eligible businesses must be for-profit, non-speculative entities and must be considered a small-business concern, in accordance with the SBA’s definition.

Microloan Program

As their name implies, microloans are small, short-term loans offered through microlenders, which are nonprofit economic development organizations approved by the SBA. They are usually offered to neighborhood, mom-and-pop-type businesses, or those small businesses that have credit challenges, because many people who can’t qualify for traditional bank loans may qualify for microloans.

You’ll find a list of microlenders near you on the SBA.gov website, and we will talk more about microloans in the next chapter.

Special Interest Loans:

Through the SBA’s loan program are several specialized loans designed for very particular types of businesses.

Special Purpose: These three 7(a) loans include the Community Adjustment and Investment Program (CAIP) intended to assist small businesses that have been negatively affected by NAFTA; the CAPLines Program, for businesses needing assistance with short-term or cyclical working capital needs (for instance, hiring additional workers for the holiday season); and Pollution Control loans, which provide aid to businesses looking to reduce their environmental footprint. (Know that some loans are not always available due to a lack of appropriations.)

Export Loan Programs: According to the SBA website, about 70 percent of all U.S. exporters are businesses with 20 or fewer employees. This loan program was designed by the SBA specifically to help these businesses develop or enhance their export activities. Within this category are several programs, including an Export Express Program, which offers expedited processing of loans up to $500,000; an Export Working Capital Program (EWCP), in which the SBA guarantees up to 90 percent of loans up to $5 million as credit enhancements, to assist the working capital needs of businesses involved in exporting (a category often dismissed by traditional lenders); and the International Trade Loan Program, which is intended to help businesses finance the purchase of fixed assets to develop or continue exporting activities.

Rural Lender Advantage: The Small/Rural Lender Advantage program is intended to assist small community or rural-based lenders with processing business loans of $350,000 or less. It includes a two-page application, an 80 percent loan guarantee, expedited processing, fax and online application submissions, and simplified eligibility requirements. Under this heading is the B&I Guaranteed Loan Program, a loan for small businesses in rural communities that is maintained by the U.S. Department of Agriculture, for the purposes of assisting businesses with working capital, machinery and equipment purchases, buildings and real estate, and certain types of debt refinancing.

Disaster Loans: The SBA offers several long-term, low-interest loans for businesses and individuals negatively affected by natural disasters. See SBA.gov for a complete list of disaster loan programs and eligibility requirements.

Veteran and Military Community Loans: Intended for businesses and individuals affected by military service, the Military Reservist Economic Injury Disaster Loan, is for small businesses that are unable to meet their necessary expenses as a direct result of essential employees being called up from reserves to active duty.

Other Financial Assistance:

For those unable or unwilling to take out loans, there may be other sources of financial assistance, including government and research grants and venture capital. While these are not provided or backed by the SBA, its website, SBA.gov, provides information, listings, and tools for finding this assistance.

How to Apply for an SBA Loan

In recent years the SBA has provided record numbers of loans to small business owners. This increase may have been driven in part by the SBA’s effort to streamline the application process and get more loan money into the hands of business owners.

Nonetheless, it is lenders, and not the SBA, that provide the applications, so you must contact a participating SBA lender directly to apply.

Each lender has its own specific requirements. In general, your application will usually require you to provide details about who you are, including your professional and financial history, as well as the finances of all principals in the business. You’ll need to describe your business, your competitors, your challenges, your plans for borrowed funds, your plans for loan repayment, your projections for the near future of the business, and your collateral.

You may also be asked by your lender to provide a lease, franchise agreement, purchase agreement, articles of incorporation, plans/specifications, copies of licenses, letters of reference or intent, contracts, or partnership agreements.

The SBA Loan Application Checklist is an 11-item list of forms and documents you’ll need to provide to your lender as part of the process:

1. Your SBA loan application (SBA Form 4)—may be downloaded from SBA.gov

2. Personal background and financial statement—SBA Form 912 (Statement of Personal History) and SBA Form 413 (Personal Financial Statement)

3. Business financial statements—a current profit-and-loss (P&L) sheet and a detailed, one-year projection of income and finances, attached to an explanation about how you intend to meet this projection

4. Ownership and affiliations—names and contact information for anyone holding a controlling interest in the business, subsidiaries, or affiliates

5. Business certificate/license—original business license or certificate to do business

6. Loan application history—records of previously applied-for loans

7. Income tax returns—personal and business for all principals for the last three years

8. Resumes—for each principal or member of the management team

9. Business overview and history—a brief history of your business and its challenges, including an explanation of why you need the loan

10. Business lease—either a lease or a note detailing the terms of the lease from a landlord

11. Items for purchasing an existing business—if your loan would be for the purchase of an existing business, you’ll need a current balance sheet and P&L of business to be purchased, its previous two years of income tax statements, a proposed Bill of Sale, and the asking price (with details about schedule of inventory, machinery, furniture, etc.)

To be sure, applying for an SBA-backed loan can be a lengthy, sometimes frustrating process. It certainly points to the need to have a solid business plan and detailed financial records.

And because lenders set their own requirements (within the context of SBA guidelines, of course), this also means it may make sense for you to work with a company that can help you find the right SBA lending partner.

The Downside of SBA Loans

An SBA loan that helps your business grow is terrific, but if you run into tough times, one of these loans can turn into a nightmare. That’s because the same federal guarantee and collateral requirements that make these loans work can work against the borrower.

SBA loans almost always require a personal guarantee from the principals of the business. And for many loans, the borrower must pledge all available capital. That means, for example, if you have equity in your home you will likely have to pledge that collateral for the loan.

Though the federal government guarantees most of the loan, that guarantee is designed to protect the lender—not the borrower. When a borrower defaults, the government doesn’t just hand the lender a check and walk away. Instead, there will be a serious effort to collect as much as possible. Collection efforts are almost always handled by the lenders themselves and may include:

1. Trying to collect from the owner of the business, who in most cases provided a personal guarantee. If necessary, they may sue the business and/or person(s) who agreed to be personally liable for the debt and get a judgment, which opens up new avenues for collection.

2. Foreclosing upon or repossessing any collateral pledged for the loan, including personal assets (a home, for example) and/or business assets (equipment, inventory, etc.).

If you fall behind on an SBA loan, reach out for help. You may be able to settle the debt for less than you owe, or renegotiate the terms while your business gets back on its feet. Your attorney, CPA or a firm that helps business owners in distress may be able to assist if you can’t do this on your own.

Another option may be bankruptcy. While it may not be ideal, it may give you the fresh start you need to regroup and try again.

Keep in mind that if you default on an SBA loan you personally guaranteed you may receive a 1099-C reporting the cancelled debts as “income,” which could create a whole new set of problems. Since forgiveness of debt is income you now owe the IRS on that “income.” Be sure to discuss this issue with your accountant or CPA if you fall behind on your loan.

Maybe a smaller loan is best for you…