When it comes to small business financing, many businesses turn to the Small Business Administration (SBA). The SBA helps small businesses obtain financing that they otherwise would be denied. Sounds a lot like the mission of The Commercial Finance Group, right? Well, there are clear differences between the two and some precautions you need to be aware of before diving into a SBA loan. In this blog post, The Commercial Finance Group, the best factoring company, will explain some precautions of SBA Lending. Contact us today!
WHAT IS AN SBA LENDING SOLUTION?
The SBA was established in 1953 by President Eisenhower to help small businesses obtain loans from banks. To be clear, the SBA does not make loans themselves; instead, when you apply for a SBA loan, you are actually applying for a commercial loan through a traditional bank or another lender that the SBA uses — the difference being that if you default, the SBA promises to pay a portion (called the guaranteed portion) of your loan back to the bank or lending institution. At its core, the SBA is an insurance company, not a direct lender. The SBA provides insurance to the banks who make the actual loan, and through this insurance it opens up more small business financing opportunities for banks. The SBA only guarantees a portion of the loan, generally between 50% and 85%. This guarantee is in effect as long as the bank follows the rules and regulations the SBA requires of the banks.
WHAT ARE SOME PRECAUTIONS OF SBA LENDING?
- Not a fast business loan. The SBA loan application process can be very long and cumbersome. As a federal government-backed entity, there are numerous rules and regulations the SBA places on its banks/lenders before it will provide its guarantee. For banks/lenders who are “preferred providers”, the loan approval process is faster. These are banks/lenders whom the SBA has delegated authority to approve SBA loans unilaterally. So, one question to ask a banker is whether they are a “preferred lender”. Non-preferred lenders/banks can still provide SBA loans, but the approval process is longer.
- Most of the SBA loans are term loans (called 504 or 7a), and as such they may not be the best type of capital to finance a rapidly growing company and their working capital needs. Though the SBA does offer a working capital product, it is cumbersome and very few banks provide or push it. Most banks push the 7(a) product. So, if you have a service business or are a manufacturer or distributor with growing accounts receivable and inventory levels, taking out a term loan using current assets is probably not a good idea. Short term assets should be financed by short term, revolving debt, not term debt. Your SBA loan officer should advise you of that, so make sure you ask them how your growth will be financed.
- More expensive than traditional bank loans. Rates are higher because the businesses applying for an SBA loan are of higher risk than those who can secure traditional bank financing. Like any insurance company, insurance is not free, so the SBA charges a fee to the lenders for the SBA’s guarantee of a portion of the loan. The fee charged goes up the bigger the loan and is3.5% for loans over $700,000. This fee is usually passed on to the borrower. This excludes any fees the bank may charge. All of this can add up very quickly, making your loan more expensive than you may have thought.
- Exposure to personal risk. If you own 20% or more of your small business and the business does not have enough collateral to secure the loan as determined by the SBA, the SBA will required to put up personal assets as additional collateral, including your home. This exposes your personal assets in case of a business failure; and one in seven small businesses fail. Small business owners often overlook this requirement for the sake of securing what they believe is “cheap” financing. It is neither cheap nor stand alone. If the business assets do not cover the loan loss, they will move on personal assets. CFG advises against using personal assets to finance your business if at all possible. The SBA will also require a personal guarantee, and this is in addition to providing personal assets. CFG requires personal guarantees, but we do not require personal assets. Remember, insurance has a cost.
- If you are rapidly growing company-you should try and separate out your short term working capital needs from your long term fixed assets and real estate needs prior to securing an SBA loan. The SBA will work with a borrower to bifurcate working capital assets like accounts receivable and inventory from the fixed assets and real estate on the front end of the SBA loan process. But you have to ask for them to do this; they will not volunteer to do it. However, if you fail to do this, the SBA will file a lien on all of the company’s assets, and as such that will shut out any working capital lender from providing you financing on your accounts receivable and inventory as they will now be in a second position behind the SBA. And no savvy, worth their salt working capital lender will be in second position behind the SBA.
In sum, an SBA loan has its place in the capital structure like many other forms of capital. The key is to understand when and how it should be used. Generally speaking the SBA 504 and 7(a) products are best for long term assets where the loan to value is too high for a traditional bank loan, when you need a longer loan amortization, and when you have a moderate or slow growing company. It is also important to remember that the SBA is like any insurance company. When a claim is made by the lender to SBA, the lender must be able to prove they have been in compliance with all of the SBA rules and regulations. If not, the SBA will void the guarantee, and the lender will have to absorb 100% of any loss. This is why you will see differing attitudes by banks toward the SBA lending program; some believe in the guarantee, others do not.
HOW THE COMMERCIAL FINANCIAL GROUP’S LENDING MAY BE A BETTER FIT
When you work with The Commercial Financial Group, there is no middleman. You speak directly to us to get all of your questions answered. As a private family-owned company, we are freer to invest in your small business since we don’t have to answer to any outside parties. Our mission is to help improve your cash flow through our financing solutions, which are asset-based loans and factoring..
With The Commercial Financial Group, our fees are straight-forward and transparent. Once we determine that your small business or start up is a good fit for ABL loans or factoring, our turn-around time is quick, often within days of your completed application. Our mission is to help small businesses and start-ups improve their cash flow, so that they are then “bankable”, meaning they can obtain more traditional bank financing. We are here to meet your working capital financing needs so your small business or start up can grow. Reach out to us today to see how we can help you with your small business lending needs!