Understanding SBA Financing

Many entrepreneurs need financial resources to start or expand a small business and must combine what they have with other sources of financing. These sources can include family and friends, venture-capital financing, and business loans.

The primary business loan and equity financing SBA programs include the 7(a) Loan program, the Certified Development Company or 504 Loan program, the MicroLoan Program and the Small Business Investment Program. The distinguishing features for these programs are the total dollar amount that can be borrowed, the type of lenders who can provide these loans, the uses for the loan proceeds and the terms placed on the borrower.

The three principal players in each of these programs are the small business, the lender and the SBA. The business should have its business plan prepared before it applies for a loan. This plan should explain what resources will be needed to accomplish the desired business purpose including the costs, the applicants' contribution, use of loan proceeds, collateral and an explanation of how the business will be able to repay the loan in a timely manner.

The lender will analyze the application to see if it meets both the lender's and the SBA's criteria. The SBA provides a guaranty to the lender's loan or provides the micro-lenders with funds to re-lend to the business. The SBA's business loan programs provide a key source of financing for viable small businesses that have real potential but cannot qualify for loans from traditional sources.

This article will focus on the 7(a) program.

The 7(a) Loan program is the SBA's primary business loan program and the agency's most used non-disaster financial assistance program because of its flexibility in loan structure, variety of loan proceeds uses and availability. This program has broad eligibility requirements and credit criteria to accommodate a wide range of financing needs.

The SBA guaranty reduces the lender's risk of borrower non-payment. If the borrower defaults, the lender can request SBA to pay the lender that percentage of the outstanding balance guaranteed by SBA. This allows the lender to recover a portion of what it lent from SBA if the borrower can't make the payments. The borrower is still obligated for the full amount.

To qualify for an SBA guaranty, a small business must meet the lender's criteria and the 7(a) requirements. In addition, the lender must certify that it would not provide this loan under the proposed terms and conditions unless it can obtain an SBA guaranty. If the SBA is going to provide a lender with a guaranty, the loan must be eligible, creditworthy and structured under conditions acceptable to SBA.

Percentage of guaranties

The SBA only guarantees a portion of any particular loan, so each loan will also have an unguaranteed portion giving the lender a certain amount of exposure and risk. The percentage of guaranty depends on either the dollar amount or the method by which the lender obtains its guaranty. For 7(a) loans of $150,000 or less, the SBA will guaranty as much as 85 percent. For loans over $150,000, the SBA can provide a guaranty of up to 75 percent. The maximum loan amount is $2 million, and the maximum guaranty amount to any one business is $1.5 million. The one exception is when a business needs both working capital and fixed assets to promote exporting in which case the SBA can guaranty two loans with a maximum level of participation at $1.75 million.

Interest rates and fees

Both fixed and variable interest rates are available. Rates are set based on the lowest prime rate* and maturity. For loans with maturities of fewer than seven years, the rate will be fixed or start at prime plus no more than 2.25 percent. For loans with maturities of seven years or more, the rate can be as high as prime plus 2.75 percent.

The SBA charges the lender a nominal upfront fee to provide its guaranty, and the lender may pass this charge on to the borrower. The fee is based on the total amount of the loan and whether the loan is short-term (12 months or less) or long term (over 12 months). The fee is computed based on the amount that SBA guarantees.

On any loan with a maturity of one year or less, the fee is 0.25 percent of the guaranteed portion of the loan. On loans with maturities of more than one year, the guaranty fee is 2 percent of the SBA guaranteed portion on loans up to $150,000; 3 percent on loans over $150,000 but not over $700,000; and 3.5 percent on loans over $700,000. There is also an additional fee of 0.25 percent on any guaranteed portion over $1 million.

* All references to the prime rate refer to the lowest prime rate as published in the Wall Street Journal on the day SBA receives the application.

7(a) loan maturities

SBA loan programs are generally intended to encourage longer-term small business financing, but actual loan maturities are based on the ability to repay, the purpose of the loan proceeds and the useful life of the assets financed. However, maximum loan maturities have been established: 25 years for real estate; up to 10 years for equipment (depending on the useful life of the equipment); and generally up to 10 years for working capital. Short-term loans and revolving lines of credit are also available through the SBA to help small businesses meet their short-term and cyclical working capital needs.

Structure

Most loans are repaid with monthly payments of principal and interest. For fixed-rate loans the payments stay the same for the life of the loan. For variable rate loans, the lender can re-establish the payment amount when the interest rates change or at other intervals as negotiated with the borrower. Applicants can request that the lender establish the loan with interest-only payments during the start-up and expansion phases (when applicable) to allow the business time to generate the income to start repaying the loan. There are no balloon payments or call provisions allowed on any 7(a) loan. The lender may not charge a prepayment penalty if the loan is paid off before maturity, but the SBA will charge the borrower a prepayment fee if the loan has a maturity of 15 or more years and is pre-paid during the first three years.

Collateral

The SBA expects every loan to be fully secured, however the SBA will not decline a request to guaranty a loan if the only unfavorable factor is insufficient collateral. What these two policies mean is that every SBA loan is to be secured by all available assets (both business and personal) until the recovery value equals the loan amount or until all assets have been pledged to the extent that they are reasonably available, to adequately secure the loan. Personal guaranties are required from all the principal owners of the business. Liens on personal assets of the principals may be required.

Eligibility

7(a) loan eligibility is based on four different factors. The first is size, as all loan recipients must be classified as "small" by SBA. The basic size standards are outlined below.

Second is the nature of the business and the process by which is generates income or the customers it serves.

The third eligibility factor is the use of business proceeds. And fourth is a category called miscellaneous factors, such as whether or not the borrower has SBA loan obligations elsewhere or the use of personal assets to qualify for an SBA loan.

More can be found out about SBA's eligibility requirements at www.sba.gov/services then select "Loan Eligibility" from the "Financial Assistance" list along the bottom.

What to take to the lender

Documentation requirements may vary, but common requirements include information on the purpose of the loan and the history of the business, financial statements for three years, schedule of term debts, aging of accounts receivable and projected opening day balance sheets. Other required information includes lease details; the amount of owner investment in the business; projections of income, expenses and cash flows; owner's personal financial statement; and resumes of the principal owners and managers.

How the 7(a) program works

Applicants submit their loan application to a lender for their initial review. The lender will generally review the credit merits of the request before deciding if they will make the loan themselves or if they will need an SBA guaranty. If a guaranty is needed, the lender will also review eligibility, and the applicant should be prepared to complete some additional documents before the lender sends its request for guaranty to the SBA.

In guaranteeing the loan, the SBA assures the lender that, in the event the borrower does not repay the loan, the government will reimburse the lending institution for a portion of its loss. By providing this guaranty, the SBA is able to help tens of thousands of small businesses every year get financing they would not otherwise obtain.

After SBA approval, the lender is notified that its loan has been guaranteed. The lender then will work with the applicant to make sure the terms and conditions are met before closing the loan, disbursing the funds, and assuming responsibility for collection and general servicing. The borrower makes monthly loan payments directly to the lender. As with any loan, the borrower is responsible for repaying the full amount of the loan in a timely manner.

What the SBA looks for:

The SBA carefully scrutinizes each loan application for the ability to repay the loan on time from the projected operating cash flow and there are sufficient funds, including the SBA-guaranteed loans, to operate the business on a sound financial basis. The SBA will also ensure that the owners and operators are of good character, that the business plan is feasible, that the management team has expertise and commitment necessary for success, that there is adequate equity invested in the business and that there is sufficient collateral to secure the loan.

SBAExpress

SBAExpress is available to lenders as a way to obtain a guaranty on smaller loans up to $350,000. The program authorizes selected experienced lenders to use mostly their own forms, analysis and procedures to process, service and liquidate SBA-guaranteed loans.

The SBA guarantees up to 50 percent of an SBAExpress loan. Loans under $25,000 do not require collateral. Like most 7(a) loans, maturities are usually five to seven years for working capital and up to 25 years for real estate or equipment. Revolving lines of credit are allowed for a maximum of seven years. For a list of lenders in your area, contact your local SBA office available at www.sba.gov/localresources.

Patriot Express

The Patriot Express Initiative combines a pilot loan initiative with SBA's traditional small business ownership training for veterans' military community members wanting to establish or expand small businesses. Eligible military community members include veterans, service-disabled veterans, active-duty service members eligible for the military's Transition Assistance Program, reservists and members of the National Guard, current spouse of any of these groups and widowed spouses of a service member or veteran who died during service or from a service-connected disability.

The Patriot Express loan is offered by SBA's widest network of lenders nationwide and features our fastest turnaround time for loan approvals. Loans are available up to $500,000 and qualify for SBA's maximum guaranty of 85 percent for loans of $150,000 or less and 75 percent for loans over $150,000 up to $500,000. For loans above $350,000, lenders are required to take all available collateral.

The Patriot Express loan can be used for most business purposes, including start-up, expansion, equipment purchases, working capital, inventory or business-occupied real-estate purchases.

Patriot Express loans feature SBA's lowest interest rates for business loans, generally 2.25 percent to 4.75 percent over prime depending upon the size and maturity of the loan. Your local SBA district office will have a listing of Patriot Express lenders in your area. More information is at www.sba.gov/patriotexpress.

CommunityExpress

The CommunityExpress Pilot Loan program provides streamlined business financing and management and technical assistance to small businesses located in distressed or underserved markets. The CommunityExpress program is offered through hundreds of selected SBA lenders throughout the nation. Under CommunityExpress, approved lenders may use streamlined and expedited loan review and approval procedures to process SBA-guaranteed loans. These lenders may thus use, to the maximum extent possible, their own loan analysis, loan procedures, and loan documentation to process SBA loans to $250,000. However lenders must provide technical assistance to the borrowers under this program.

Special Purpose 7(a) Loan Programs

The 7(a) program is the most flexible of SBA's lending programs. The agency has created several variations to the basic 7(a) program to address the particular financing need of certain small businesses. These special purpose programs are not necessarily for all businesses but may be very applicable to some small businesses. They are generally governed by the same rules, regulations, fees, interest rates, etc. as the regular 7(a) loan guaranty. Lenders can advise you of any variations.

Should you need further information on the 7(a) program, visit www.sba.gov.

Contact a Small Business and Technology Development Center near you for assistance with business development issues.