Insights into SBA Lending
The BBJ asks 4 lenders why SBA loans make sense for small businesses.
Source: Birmingham Business Journal, 12 July 2015
The Alabama SBDC Network provides no-cost business counseling, and assists existing businesses and start-ups with their capital needs, including conventional and SBA-backed loans.
Q: What are the advantages of an SBA loan compared with other types of financing for small businesses?
William Craig Brown (Partner, Engel Hairston): The two biggest advantages that pop to my mind for using SBA loans are cash retention and long-term fixed rates, particularly when financing acquisition or expansion of capital assets. With a 504 loan the minimum down payment is 10 percent, so the borrower is able to keep more money in his pocket upfront, which will help alleviate operational or other working-capital needs. The other advantage is being able to diversify a portion of the debt with SBA financing, which offers a 20-year fixed rate on that portion of the financing. The long-term fixed rate also allows lenders to offer a more competitive blended rate than they might otherwise give for the same credit conventionally. Under the 7(a) Guarantee Loan Program there is an incentive for the lender to participate with the business owner in financing their small business needs. The guarantee-loan program also offers lenders a lot of flexibility from lines of credit for account receivables or financing business acquisitions. Lastly, SBA’s effort to expand capital access and streamline their systems are making it easier for the lender to participate and pass these advantages along to the small business borrower.
Mark Woods (Vice President of SBA Lending, USAmeriBank): Small businesses do not have a lot of financing opportunities. It’s difficult for them to get a standard line of credit, especially in today’s credit environment. You have to be very clean, almost a perfect opportunity. But when SBA comes around you have a different view of the loan and the opportunity, and that’s what these small businesses generally need. They may not necessarily have credit where it needs to be on the conventional side, but with SBA we take a broader view of the credit. Or they may not have the collateral needed for a conventional loan, but with the SBA guarantee it makes it easier to get a loan that they probably couldn’t have gotten conventionally. It just provides a little more flexibility for small businesses, which they really need. Because their only other option a lot of the time is to turn to venture capitalists or some high interest-rate financing that can kill a small business. So SBA really becomes a good program for them. Most any loan now is 50-50. It could be conventional or SBA.
Brown: SBA lending remains active, but not quite at 2012 levels. Year to date (as of June 9) in Alabama there have been 227 different 7(a) loan approvals for roughly $118 million. And on the 504 side, there have been 34 approvals for about $22 million.
Woods: What’s interesting is that of those 227 approved 7(a) loans, a vast majority have been SBA Express, or less than $300,000. You don’t see a lot of the larger SBA loans like you might have in the past. Instead, a lot of the banks are doing SBA Express.
Heather Jones (SBA Lender, First Commercial/Synovus Bank): There are three big advantages to using an SBA loan to finance your business needs. First, SBA loans allow longer amortizations than conventional financing, which results in a lower monthly payment and increased cash flow for the borrower. They can use the cash flow saved for further investment in their business and build net worth in their company faster than they could with shorter terms. Second, at Synovus we use the guaranty to mitigate shortfall of collateral. While SBA requires personal real estate to be pledged as collateral if the loan is not fully secured, we can usually get comfortable if the loan is not fully secured if the business has a proven cash flow record. And third, it is common for businesses to look for SBA financing because of their lack of liquidity available for a down payment. SBA does not have a minimum equity injection anymore, but most banks still allow for a smaller down payment than they do on conventional loans, typically around 10 percent. Even if a borrower has more than that to put down if they had to, it is beneficial for a business to hold on to that cash and use it in the business if it results in growth and opportunity. We want our businesses to be successful and we believe freeing up cash flow and liquidity to allow them to invest properly in their company supports that success.
Tim Dollins (Vice President-SBA Specialist, Regions Bank): There are several advantages to an SBA loan, particularly through the 7(a) guaranteed lending program. First, how much equity injection to require is typically up to the lender in most cases, often 10 percent. So down payments are comparatively low and helps to preserve capital and liquidity for small business. Second, the allowable terms are more liberal, up to 25 years for real estate, 10 years for the acquisition of business assets, and seven years for working capital, allowing for a lower payment, therefore more income left over for the business. Finally, collateral is not the primary driver in making an SBA loan. So often even if there is not enough collateral to fully secure the loan, the SBA guarantee mitigates the under-secured nature of many small business loans, making capital accessible where otherwise it would not be available.
Q: What can businesses use SBA loans for? Can I get an SBA for a startup venture or to buy a new business?
Woods: The biggest advantage for a start-up business is utilizing an SBA loan. Because conventionally it will be very difficult, since a new business is all projections based. No matter what you have, it’s just very difficult to do a conventional loan for a start-up business. Purchasing a fairly new business is a great opportunity for an SBA loan. If it’s a business that’s been around for only about a year, we don’t have a lot of historical financials to look at. There’s not a lot to go on, an SBA loan becomes a great opportunity, because SBA looks at what you’re forecasting. That’s probably the biggest opportunity. But there is a lot you can use an SBA loan for, from financing new equipment to adding inventory. They usually tell you that to qualify as a small business you can’t have more than $20 million in revenue, but I disagree. There’s different ways that formula can be broken down. So you really need to talk with somebody who knows what they’re doing and see if they can figure it out.
Jones: SBA loans can be used for any legitimate business purpose, including refinance of debt used for business purposes. If the proceeds will be financing real estate, it must be at least 51 percent occupied by the owner to qualify, 66 percent if it’s new construction. SBA loans can be used for the costs associated with starting a new business, though it is up to the bank if they are willing to do so. Start-ups are definitely risky and banks typically need to have more than just the SBA guaranty to offset that risk. At Synovus, we refer our customers who are requesting financing of a start-up to the Small Business Development Centers (SBDC) to work with them on their business plan and projections. If they have worked with the SBDC, we know they have received quality consultation and have worked through their numbers thoroughly. We are also looking to make sure we have industry experience and/or business ownership or management experience. We see this as a true key to success and any short-term training offered cannot overcome the years of experience it takes to be ready to own your own business. If the borrower has an outside source of income that can support household expenses and even the loan payment until the business breaks even, that definitely increases the credit worthiness of the loan as well as putting down additional equity and being fully secured.
Dollins: SBA loans can be used for a variety of purposes: to start up a business, to expand an existing business, to purchase fixed assets like real estate or equipment. Or for working capital, an SBA loan can even be structured as a line of credit. Each bank makes its own credit decision when approving an SBA loan, so one bank may not be able to do start-up loans, but might be able to make larger un-secured loans for expansion of an existing business, or the acquisition of an existing business.
Brown: There’s a lot of room in what SBA considers to be small business. Generally, small is considered to be business – including affiliates – with net operating income averaged over a two-year period of less than $5 million and a tangible net worth of less than $15 million. That definition covers a lot of ground. The 504 loan is primarily used for buying land, buildings, or for capital expansion. The 7(a) loans are typically used for inventory, accounts receivable, working capital or business acquisitions. Both can finance startups. It may be easier to tell you what you can’t do versus what you can do. You have to be a small and organized for-profit within the United States. As long as you cover those and don’t fall into certain categories that the SBA says are not allowed, like gambling, then the world may be wide open for what you can use SBA for.
Q: How does the SBA loan process differ from traditional business loans?
Jones: The process isn’t that much different than a traditional business loan. SBA loans usually take longer for the borrower to complete the loan application because of the amount of paperwork SBA requires for the loan package to be complete, and the closing process usually takes longer because of the paperwork SBA requires to document the file. Most of the requirements are similar to traditional business loan requirements except that we can’t waive any of the documents. If we don’t document our file appropriately, we could lose the guaranty on our loan. A banker can waive some documentation or collect it post-closing on a traditional loan and therefore move it through the process a little faster. Our goal at Synovus is to utilize our streamlined process to get our borrower to the closing table as quick as we could if it were a traditional loan. Sometimes closing obstacles can cause delays, but if no issues come up, it is a fairly smooth process. The key is constant communication and team work. Everything we do has the customer experience as priority.
Dollins: The SBA process is somewhat more intensive than a conventional loan, primarily because each project must comply with the Standard Operating Procedures (SOP) of the Small Business Administration. To insure that the guarantee is in place and enforceable, banks must strictly comply with the guidelines in the SOP. The less familiar with the SOP a banker is, the longer and more frustrating the SBA lending process will ultimately be. To insure that the loan closes in a reasonable period of time and is as smooth as possible, a borrower should ask how many SBA loans a lender has closed in the recent past, and how up to date they are in their knowledge of the SOP.
Brown: I recently talked with a guy for a hotel deal, and there were several members who were part of the LLC. And he said, “I’m just a silent partner. I don’t have any management or control over the daily operations. Why am I having to guarantee this?” It all goes back to the risk that the lender is taking. There are certain thresholds as far as ownership percentages are concerned about whether a person is going to be giving a full guarantee or a limited guarantee, and there are ways they can work around that. But as far as the process is concerned, coming out of the recession, the paperwork now between SBA and conventional deals is very similar. Lenders are looking at the interim and historical financial statements, tax returns, credit reports and getting the organizational documents. It’s the same cadre of documents that a lender would want to have to complete due diligence on a conventional side as they would the SBA side. There are a few extra steps as far as the SBA is concerned like going through the eligibility process and putting the application together. But SBA has made a big push for a lot of this to be collected and submitted electronically. It goes to central processing centers, all with the idea of giving you a faster turnaround and moving you more quickly to approval. SBA may have gotten a bad rap for having more steps or hurdles, but I think that’s largely been equaled out because of the regulatory changes that have come into effect over the past few years, which have leveled the playing field. SBA has really worked to streamline the process by which this information is submitted and reviewed. It seemed like the process would bog down over one thing that was the major glitch. We were waiting on one person to review it, or waiting for one answer for final approval, but SBA has worked hard to try to alleviate that as much as possible. They promise a 48-to-72 hour turnaround on some responses. So the process is improving.
Woods: I wish we could make an SBA loan as easy for a client as a conventional loan. But let’s be clear, the SBA process is going to take longer. Period. You basically have a dual approval process. You have to get approval from the bank for credit, just like you would on a conventional loan, but then you also have to go to the SBA for approval. You have a built-in double approval, so it’s going to take a little bit longer. I agree that the process itself is getting closer conventionally to SBA, but you still have a lot more you have to do upfront on an SBA loan. And the documentation for an SBA loan is much more stringent than it is on the conventional side because you have to make sure you keep your guarantee for the banks. Interestingly, SBA is regulated and has to be audited also. And in their last audit, they were told there are some things that SBA has to do better. Well, unfortunately when things have to be done better, that means we’re going to have to tighten up the process. So on the documentation side there are more signatures up front, there is more paper processing that goes on initially so on the back end the banks can maintain their guarantee. But there is this idea that SBA is so much harder and a nightmare. I believe that’s a misnomer. Because if the bank does it well, it can flow very smoothly. Make no mistake, it is a different process with a little more paperwork. But in the long run, you can get a lot of satisfaction from an SBA loan.
Brown: I can’t emphasize that enough about going to somebody who knows SBA and knows the process so they can manage expectations. That’s where the wheels come off the most, when there is a false expectation set in the mind of the borrower about what has to happen and how quickly it will happen. If you find the right person to guide you through the process, then it’s very manageable. I’ve dealt with a lot of people who have come through the process and said, “Wow, this wasn’t nearly the nightmare that I’d been told it was going to be.” The reason being they had the right guide.
Woods: The mistake that bankers make in general is we say, “This box is where it fits,” instead of listening to clients. That’s what we try to do. We say, “Tell me what you’re doing, and then we’ll find what product best fits you.” And I think that is even more critical in an SBA process. You cannot go out there selling an SBA loan. You have to let them tell you what they need, and make sure that it is the best fit for the customer and that it will meet SBA standards.
Q: How has the low interest rate environment impacted the SBA loan program?
Dollins: The SBA guarantee has a value on the secondary market. It is bought and sold like an investment. Investors who purchase SBA guarantees get an investment tied to an index in a rising rate environment as well as a U.S. Government guarantee of principal, which justifies the payment of a premium for the investment. Since the risks associated with SBA loans are higher than most conventional loans, SBA loans are often priced with a floating rate to reflect and share in that risk with the borrower. These floating rate guarantees fetch higher premiums today than ever before, which motivates lenders to make more loans. While pricing competition among banks is real, businesses have benefitted from the easier access to capital provided by the active SBA guarantee secondary market.
Woods: It’s affected it to the extent that an individual feels like loan rates are so inexpensive now, that when they get an SBA loan it should be the same way. Unfortunately, the reason they have to go to an SBA is they don’t meet that conventional framework that allows for those low rates. And that’s very difficult for us as a banker to explain to them. Yeah, you have a great idea and business plan, and you’re a great person, but unfortunately you don’t qualify for the low interest rate. That loan is SBA for a reason. You might be lacking collateral or liquidity, or you are struggling in the credit area. Whatever it might be, that leads towards a higher interest rate. So if it’s affected it in any way, it’s that we have to be very upfront and clear with the client on why this opportunity doesn’t work for the low interest rates that you’re thinking.
Brown: Of late, there have been folks on the market tossing around 3.9 percent for 10 to 15 years, and that’s pretty hard to beat. But generally the SBA loan programs remain competitive. The 504 full term effective rates are hovering now around 4.8 percent for 20-year bonds and much less for 10-year bonds, though it fluctuates as a function of the bond market. It’s still a very competitive rate when you’re looking at other types of conventional commercial deals that are hovering somewhere around 5 to 5½. We all expect rates to fluctuate in the years to come, and that there will be an increase in pricing due to a change in the prime rate. If that’s the case, then I think it will have the effect of giving SBA loans a slight competitive edge. With the 7(a), rates are priced somewhere around 5½ to 6 and those are usually pegged at prime plus 1½ to 2¾ adjusting quarterly. So the pricing structure is a little different. But by and large, SBA remains fairly competitive in the current interest rate environment.
Woods: There are rates out there now that are 4 to 4½. That’s generally on a real estate-backed loan opportunity. So when somebody is looking at SBA and it’s 5.75, they don’t understand why that’s the case, and you have to explain it.
Jones: More borrowers have probably been encouraged to apply for SBA loans in this low rate environment, and several of them can show the ability to repay at these rates. Whereas if they were much higher, they could not have qualified for financing. This allows for businesses to grow, which results in more jobs, investment in small business and beneficial impacts to our economy.
Q: What can businesses do to improve their chances of getting an SBA loan? How can businesses make themselves attractive to borrowers?
Brown: In general, be organized. There is going to be a lot of paperwork to submit. Financial statements, tax returns, organizational documents. You’ll need to have done a decent job of keeping track of all of these things. Most business owners are not CPAs, and they’re not focused on the financial statements. They’re not an attorney, and they’re not focused on corporate governance issues and the organizational documents. Their focus is on the business. So all of this other stuff is just ancillary and it’s a real pain to have to deal with. But those are the things that are going to be asked for as part of the application and the closing process. So having all these things in order will make it a lot easier. The other thing is having a good business plan in place, whether you are a start-up or are looking to expand your business. Telling people why you can do what you’re going to do is a key factor in building a compelling case why you should get the loan.
Woods: Let’s look at it from the client’s point of view. One, it’s intimidating enough to come in and figure out how to get a loan for your business. There is an innate concern about how to do that. Really what we want to see is if this individual is well prepared and they know what they’re talking about. That doesn’t necessarily mean they’re going to get the loan. But what I don’t want to see is a client come in unprepared and without a business plan. The one thing I always want to see as a banker is a business plan. That tells me the individual has thought through the process, they understand what they’re doing and they want to go forward. Not just having it in your head, but being able to show me the research you’ve done and where you plan on going makes it very attractive for us to look at it. If your business plan is well thought out, you’re going to have already answered a lot of my questions about whether you’re qualified. That makes it extremely attractive for us. Because we’re risking our money to see if you’re going to succeed. So what we want to see is, are you prepared to succeed? What I see so much is people who know their business, but when it comes to the back office, it’s like a horror movie. I’m scared to see it. If you want to expand, show me the track record of your financials and show me a good reason why there is a need for expansion. It’s just being prepared. The SBA here locally, Rod Perkins and his group can link you to individuals who will help you build your business plan for free.
Brown: The SBA web site, www.sba.gov, has a wealth of information that is easily accessible, including a drop-down for creating your business plan. Also SCORE, the Service Corps of Retired Executives, offers free advice in putting all this together. You can check them out at www.score.org or as a link from the SBA web site. The flip side of all this is, if you have existing obligations, pay those. Your lender is going to look at how well you’ve performed in the past, especially if you’ve had other SBA loans and looking for a new one. Defaulting on other SBA obligations is a sure-fire way to get yourself turned down.
Woods: If you have tax problems, you can’t set an SBA loan. Period. If you’ve defaulted on any kind of lien or owe money to the government, you cannot get SBA.
Jones: For existing businesses that are looking to expand, it is important to communicate what the business looks like today and what the expansion will do to improve the business. They need to demonstrate that they are currently able to pay their debts and expenses, but that an expansion could grow that even further. Many times when a business is not succeeding, they think expansion will fix that for them and that is not the case. When we look at expansion loans we look at the existing operations and financial position first, and then look at projected growth to see if it makes sense. For new businesses, it is important to get the experience, education and training under your belt before trying to start your own business. It is also important to save up your money to invest in the business yourself in the form of equity into the project. SBA does allow for equity to be gifted or even borrowed if there is an outside source to repay it, but creditors like to see the borrowers with some skin in the game.
Dollins: There are several things a business owner can do. First, check your credit and dispute incorrect items prior to making application, and make sure you are up to date and current on all of your obligations both business and personal. Then Interview your lender. What are they looking for? A 15 or 20 minute conversation can give a borrower a fairly clear view of the lenders expertise and appetite for the type of loan the borrower is seeking. This will avoid wasting your time and theirs if it is not a good fit. Next, organize your information. When a lender gives you a list of items to collect, put it together neatly and supply it all at once. This will make the decision-making process much easier and faster for the lender and improve your chances for getting the financing you are requesting. Be realistic. If $10,000 will get you where you need to be, requesting $1 million will hinder, not help you. Finally, if you need help, contact the local Small Business Development Center or local SCORE chapter. They can help you put together your loan request and will actually help you find a lender that will help. This is a free service funded by the Small Business Administration.
Q: What are some factors businesses should consider and questions they should ask when choosing an SBA lender?
Woods: When you walk into a lot of banks you’re going to see a sign that says “Certified SBA lender.” But just because you have an SBA sticker in your window doesn’t necessarily mean you can do SBA lending. What you need to find out is do they have a dedicated department to SBA lending, not an individual who handles their SBA loans. There is a large difference. A lot of banks have an SBA individual who handles SBA lending, but not a department. It is critical that you find a bank that has expertise in SBA lending, and having a dedicated department helps all the way through. Because when you do a loan you have the credit underwriting, packaging, closing, follow-up. All that has to be done, and if it’s not done within that bank it’s farmed out. Then you have two or three middlemen to get everything organized and make sure everything is right. So it’s critical that you have a bank that has a division that does all of that, and all the individuals in there are well-versed in SBA. The process is already going to be different for the client, so you want it to be fine-tuned, and that’s what you’re going to find in a good bank.
Jones: It goes without saying that borrowers want to know how long the process is going to take. Make sure your lender can provide timelines for approval and closing as well as the things that can cause delays so those can be addressed early on. Borrowers should also ask if the bank can handle all their business needs. Checking accounts and credit cards are easy, but if you have treasury management needs, what are the costs for those services? If you export, you will want to make sure the bank you choose can support international wires, letters of credit, forward commitments, etc. Unfortunately, many banks have SBA lenders who handle the SBA loan request but don’t have a banker involved who can handle the rest of the needs. At Synovus, we are very focused on the overall relationship and use a team approach to meeting all of our customer’s needs. It is also important to ask your SBA lender if your loan will be packaged by a contractor or if all of the work is done by the bank. If the bank contracts out any part of the process, they are probably not fully committed to the program as they have not yet invested in the staff needed to handle the specialty nature of SBA lending. Lastly, I would suggest asking what volume of SBA loans they have done over the last five years and how they are ranked nationally. This will show you the bank’s commitment to the program and small business financing.
Dollins: A borrower should ask how much experience the lender has with SBA guaranteed lending. Some lenders have delegated authority to make decisions and comply with the SBA SOP through the Preferred Lender Program (PLP). By choosing a PLP lender, the borrower will know that the SBA recognizes the financial institution’s expertise in underwriting, processing, closing and servicing SBA-guaranteed loans without the extra time and hand-holding required for lenders without delegated authority from the SBA.
Brown: I would first want to talk with somebody who is similarly situated, who is in the same business and has gotten an SBA loan before. What was their experience? It’s kind of like finding a good doctor. You usually talk to other people about their doctors and find out what their experience is. There are a lot of knowledgeable folks out there who understand SBA and will do a fine job in putting the package together and guiding you through the process. You just have to know who does it. So talk to fellow business owners. They’ve likely been there and done that.
Woods: Rod Perkins will give you three or four names. He can give you statistics about who is doing the most in the area and what type of loans they’re doing.
Q: What is the difference between a 7(a) loan and a 504 loan?
Jones: The 7(a) loan can be used to finance all business needs, including real estate, working capital, inventory, equipment and debt refinance. The 504 loan is used to purchase or construct fixed assets, mainly real estate and equipment. While 504 loans allow for long-term fixed rates on the second mortgage that SBA funds, 7(a) rates are typically variable but the amortization can go out to 25 years instead of 20, which can result in a lower monthly payment. The 7(a) loans have a three-year prepayment penalty, while 504 loans have a 10-year prepayment penalty. On 504 loans, borrowers do not have to pledge additional collateral if the loan is not fully secured – although banks may require it during the construction period – while 7(a) loans require personal real estate as collateral if the loan is not fully secured with business assets, provided the personal real estate has more than 25 percent equity in it. Both programs have pros and cons. When we talk to a borrower about both programs, we do a side-by-side comparison of their specific loan and let them decide what the best structure is for them. All borrowers have something that matters more to them than something else. Our job is to provide them the information so they can make an informed business decision.
Dollins: An SBA 7(a) loan can be used for a variety of purposes, to acquire a business, including goodwill, to fund working capital, to expand, or even in some cases to start up a new business. It can also be used to refinance existing debt or to buy real estate or equipment, or even to construct a new commercial building. The 7(a) loan is a guaranteed loan, meaning the bank gets an SBA guarantee – typically 75 percent of the loan – to mitigate the risks of making a loan that might not have enough collateral or that requires extended terms to insure repayment. The bank makes the loan directly, and the SBA issues a guarantee on that loan as long as the bank complies with the rules. The 504 loan is a loan made directly by the SBA through a Certified Development Company, typically for financing fixed assets. If a business seeks to buy a building, the SBA will allow up to 90 percent financing. Essentially, the borrower injects 10 percent into the project, the bank finances 50 percent in the form of a first mortgage, and the SBA finances 40 percent in the form of a second mortgage. The 504 program is great for constructing or buying a building, and having a low loan-to-value ratio is an inducement to a bank to make the loan.
Brown: Structurally the 7(a) is a guaranteed loan and the 504 is a participation loan. With the 504 you have a lender partnered with a certified development company, which is an SBA lender. After the SBA money is on the table, the bank retains a first lien position and the SBA lender, the CDC, has a second. So they participate together to complete financing. Usually the bank puts 50 percent of the funds into play, with the CDC putting in 30 to 40 percent and the borrower injecting the rest. That structures allows the borrower to retain more cash up front. The 504 loans are typically used for land, building, heavy equipment and machinery. The 7(a) is wholly the lender’s loan. All of the money on the table is from that lender. What they have from SBA is a guarantee of usually between 75 and 85 percent of their loss should things go bad. That’s how SBA is enhancing the value of the credit for that loan. The 7(a) loan covers the things a 504 loan can finance as well as working capital, inventory, debt refinance and more. It’s a versatile product.
Woods: What you see in the 7(a) is it can capture all, while the 504 is a more specific loan for a certain item. SBA regulations on a 504 are much different from the 7(a). The 7(a) gives you a broader base of what you can finance. The biggest reason people lean toward a 504 is they want that 20-to-25 year fixed rate. That’s what the SBA allows. The bank also has to agree to do it for 25 years.
Q: How do the interest rates and fees on SBA loans differ from conventional loans?
Dollins: Since SBA loans often carry more risk and insufficient collateral, they are often priced with a floating rate. However, each bank can make its own pricing decisions and can be flexible with the rates that are charged. The rates may be slightly higher because the bank must actually share some of the interest income with SBA, around 50 basis points historically. So in order to remain profitable, that cost is typically passed on to the borrower in the originally negotiated interest rate. The SBA also charges a guarantee fee, in most cases this is approximately 3 percent of the guaranteed portion of the loan. The guarantee fee goes to the SBA and acts like a credit insurance premium, it covers the guarantees for losses in the SBA program. The guarantee fee is typically a part of the total project and does not have to be paid out of pocket, it can be financed. It is notable that the 7(a) guaranteed lending program is currently self-sufficient and does not require a government subsidy in operating the program. Banks may charge a packaging fee for their services in closing a 7(a) loan. This is typically $2,500. In order to charge more than that, a lender or packager must provide a detailed breakdown of charges and justify each line item. A conventional loan may have an origination fee, but not a guarantee fee. The difference is that if a person were buying an existing business for $2 million, the loan could have well over $2 million in unsecured debt, which often exceeds a bank’s unsecured lending authority, or internal lending policy. With SBA guaranteed lending, this loan is a possibility, and the cost of the guarantee fee is part of what enables lenders to make loans that otherwise would not be possible.
Woods: The interest rate can vary. But on the fee side, there are some additional fees in an SBA loan. It depends on the loan size. It becomes a math problem. In an SBA loan, all those costs can be financed in the loan itself, which makes it easier for the borrower to keep cash in their pocket. In a conventional loan you’re going to pay your closing costs up front, and with most banks there are origination fees. So you’re going to have other fees associated with a conventional loan that are all going to come out of your pocket at closing. With an SBA, it all rolls into the loan. Cash is king. You need cash in hand. So if you have the opportunity to roll that in, it can make a lot of sense to do it that way. SBA is going to have a few more fees and cost a little more, but in most cases it’s better off for the business in the long run.
Brown: Under a conventional loan you’re still going to have environmental costs, appraisal costs, title costs, attorney costs. With SBA loans you have those plus other statutory fees that are a cost of the SBA loan. The net effect is that the SBA loan can cost maybe 2½ to 3 percent more, but is that worth it to get a lower down payment or longer term? It’s all about cash retention, and that should make a big difference in how you weigh the costs. What’s the true cash that I have to come up with out of my pocket to get this loan closed versus the true costs that I can finance over the term of the loan?
Woods: The fees are going to be a little bit more on the SBA side because you pay the guarantee fee, which you don’t have on the conventional side. But most of your other costs are going to be similar.
Brown: If you get to keep $20,000 or $30,000 in your pocket instead of paying that upfront to close the transaction and put that back into your business, I think the return on that money over a period of time will far exceed the additional costs that you pay to get the SBA loan. It’s a net benefit.
Woods: Why are you going for a loan? You need cash. That’s the reason most of the time. So you don’t want to be pouring out your money in closing costs.
Jones: SBA loans typically have a higher interest rate because there is some risk involved, or else the loan would not need a SBA guaranty. The loan may not be fully secured or the longer amortization may be needed to ensure sufficient cash flow to cover the loan payments. Interest rate is determined by risk so borrowers should expect this to be higher than a conventional loan. SBA 7(a) loans do not allow origination fees. The only fee charged is the guaranty fee, which is 3 to 3.75 percent of the guaranteed portion of the loan, depending on the loan amount. This fee is paid to SBA and is how the government pays for the program without having to use tax payer dollars. However, this fee can be rolled into the loan amount and amortized and it is only paid once, where an origination fee is typically charged each time the loan renews. Because the SBA loan is fully amortized, you never have to worry about having to get updated appraisals or going through the renewal process either.
Q: What are some misconceptions about SBA loans among business owners?
Brown: The ones I hear the most are it’s impossible to do and takes forever to close. There are some horror stories, and I don’t want to take anything away from the people who have been slugging away for two years working on the application and going through the approval process to get it done. But we’ve had some that from start to finish have been three or four months, and from the time the authorization hits my desk to closing is within 15 to 20 days. So it is possible to be able to navigate the SBA process. It goes back to knowing somebody who knows the process and is able to get it done. Another misconception is about the amount of government control or intervention. The government is not going to be in control of your business if you get an SBA loan. The government is not there to micro-manage your business or run it. These are the lenders’ loans. The government is there to help alleviate some pressure on your lender if there is a default. There also is the misconception that SBA is only for bad credit. Even if you have good credit, SBA may still be a good fit, depending on your circumstances. We close a lot of deals for people who have very solid businesses and use SBA for their advantage. Lastly, these programs are supposed to be budget neutral for the government. They are funded through the fees that are generated by the loans. So these loans are not costing taxpayers additional dollars.
Woods: There are three key misconceptions about an SBA loan. The first misconception that really needs to be cleared up is that it’s a last-resort type of opportunity. It is not a last resort. It could not be more opposite. What people should think about with any loan is, “What fits my business best?” Second of all is the process. People think it takes forever and is a nightmare. You hear more horror stories about SBA because it’s easier for people to harp on. But conventional lending has nightmare stories, too. It goes back to choosing the right lender and setting that process in place. My mom use to tell me all the time, “A failure to prepare on your part does not constitute an emergency on mine.” It’s the same for a client. This process can be very easy if you work with your bank and provide the needed information. If we can get that, this process can go very smoothly. A lot of time the process lingers because of clients taking time to get what we need. The other thing I hear so much about is reporting. The client thinks there is so much more we have to verify yearly for an SBA loan. That is also not the case. With conventional loans, we’re asking for tax returns, financial statements, company reports. It’s the same things as with an SBA. So the reporting part is not near the nightmare that you hear people say.
Jones: The main misconception is that SBA loans are for start-ups with no collateral. SBA guaranties do allow a borrower to get a loan that they may not have been able to get conventionally, but the credit still has to make sense. Even with a guaranty, the bank stands to lose money if the business fails. We use the SBA guaranty to mitigate one or two risks, not all of them.
Dollins: One misperception is that SBA loans are too hard to get. It is true that the documentation requirements are higher, however, the rewards can be life altering for the business owner. Interviewing your lender and getting a clear understanding of what they are looking for, and listening to their recommendations as you prepare to make an application for an SBA loan, will dramatically improve the process for all parties. One of the reasons the process is frustrating for business owners is that they work with a lender who has little or no experience which delays and complicates obtaining an SBA loan.
Q: What are some of the current trends you’ve noticed with SBA loans in terms of borrower demand, approval rates, etc.?
Woods: You still have that entrepreneurial spirit out there. We still have a lot of people who want to start businesses and buy new businesses. So the SBA demand is still high. But people don’t necessarily know that it’s an SBA loan that they need. They come in for a conventional loan and it ends up being SBA. As far as the approval rate is concerned, I don’t know if statistically there are more being turned down, but you better have it laid out well. Because after the SBA got audited, they now want to make sure everything is in place and it is a good loan. It’s not necessarily more stringent, but you need to make sure you know what you’re doing, which is no different than on the conventional side. You’re seeing a lot more boutique businesses coming in, not necessarily the standards that you’ve seen in the past. Breweries, furniture, gun stores. It’s all over the board right now.
Jones: Construction loans are definitely on the rise, which makes sense given where we are in our economic recovery. We are also seeing a lot of loans for businesses to expand, which is exciting. We try our best to provide guidance as to whether a request is something we can do or not as early in the process as possible. If we know another lender has the ability to do something that we don’t, we will let the borrower know that, too. We can’t say yes to everything, and if we can help them some other way, we will. And we will do it as soon as we can so we don’t waste the borrower’s valuable time.
Dollins: Demand for SBA loans has increased over the last few years as credit tightened and banks have sought a way to mitigate the risks associated with small business lending. Demand ebbs and flows from month to month, but banks are definitely actively seeking SBA loans to put on the books. Now is an excellent time to seek SBA financing.
Brown: SBA 504 activity in the country spiked in 2012 while 7(a) lending dropped, but we’ve seen the numbers reverse over the past three years. Third quarter 7(a) volume for 2015 is about $14.6 billion and on pace to beat 2011 records. Although 504 volume has picked up from previous years, it’s still about 25 percent off 2012 levels. The 2012 volume and popularity was due primarily to the SBA 504 refinance program that sunset leaving about 400 unapproved deals in the queue. It would be a much-needed and popular program to revive. There’s about $300 billion worth of commercial-secured debt that will be coming due by 2017. That’s about 2½ times the amount that mature between 2012 and 2014. This massive amount of debt coming due within a very short amount of time would make it very attractive to have the SBA 504 refinance program back in place.That’s something Congress is considering under the CREED Act (Commercial Real Estate and Economic Development). It has wide bipartisan support and would allow borrowers with conventional deals that would be otherwise eligible for SBA financing to refinance using the 504 program. That’s good for the lender, because it allows the lender to take 40 percent of those funds and put them back into play somewhere else without having to raise any additional equity or balance-sheet capital. And it’s good for the borrower because now they’re able to move a portion of that debt to long-term, fixed-rate financing. It’d be a cost-effective way for the government to stimulate lending activity and infuse money back into the economy. Right now, I think there are a lot of people wondering what they’re going to do in the next couple of years in terms of financing this debt.
Woods: Refinancing is one of the things we see a lot of now, because it will help their cash flow. Companies will come to us with a 7(a) needing to make a purchase of a bigger piece of equipment or maybe a new building, and they will want to refile all their existing debt and make it one loan payment. This will increase business cash flow.
Q: Is it easier today to get an SBA loan than it was five years ago?
Jones: It is easier to get any loan today than it was five years ago, and that goes for SBA, too. Five years ago SBA was probably the only resource a bank had to get any loans approved. Now, conventional loan approvals are on the rise but so are SBA approvals. So it’s good for everyone, especially businesses.
Dollins: It is definitely easier to get an SBA loan that it was five years ago. Despite improvements in the economic climate, lenders are eager to take advantage of the credit enhancements offered by the SBA lending programs to reduce risk and expand customer relationships.
Brown: SBA has worked really hard to streamline the process. They are still going to be asking you by-and-large for the same information that they did five years ago. But they are taking strides to make the process a little bit easier. So from the standpoint of having information readily available and the advent of some technology, the process can be a little bit cleaner and more streamlined with quicker responses.
Woods: Is the process easier than it was five years ago? Yes, absolutely. Is it easier to get approval than it was five years ago? Doubtful. Because with the credit environment as it is now and SBA being audited, they have to make sure they’re doing good loans. So on the approval side, I’m not saying it’s more difficult, but it just needs to be very well thought out and you need to be prepared with a good presentation when you come to get your loan.
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