By Justin McInerny
Introducing the Small Business Administration.
As noted on its website, the Small Business Administration (SBA) was created by Congress in 1953 as an independent agency of the federal government to aid, counsel, assist and protect the interests of small business concerns. Simply stated, the SBA's mission is to help Americans start, build and grow businesses. It provides many services to entrepreneurs including marketing advice, business planning advice and, most importantly for the purposes of this newsletter, loan programs. Note that the SBA is not a lender or a bank and hence the SBA technically never directly works with the borrower. Nevertheless, the SBA and its rules are the most important pieces of these lending puzzles.
SBA 7(a) LOAN PROGRAM - WORKING CAPITAL
The SBA's two most popular loan programs are known as the 7(a) program and the 504 program. The 7(a) program (the names come from their respective section numbers in the Small Business Act) is probably the most popular SBA loan program. It is largely intended to provide working capital for a business and does not require collateral.
The SBA itself does not actually lend any money to an individual. Rather, it helps the loan get approved by guaranteeing a certain portion of the loan. In other words, if the borrower defaults, the lender can count on getting at least a portion of the loan paid off by the SBA. Lending institutions such as banks handle SBA-guaranteed loans in much the same way as any other loan, except that they and the borrower have to go through certain additional SBA-mandated processes.
FIRST THINGS FIRST: CHECK YOUR ELIGIBILITY
Before starting the application process, see if you and your business are eligible for an SBA 7(a) loan in the first place. I will outline some of the eligibility requirements here, but you should consult an experienced SBA loan officer and the SBA's website for comprehensive eligibility details. You should consider the following eligibility requirements before you start the loan application process.
Business size limits according to industry:
1. Manufacturing: Up to 500 employees
2. Wholesaling: Up to 100 employees
3. Services: Annual sales up to $7m
4. Retailing: Annual sales up to $21.5m
5. Construction: Annual sales up to $17m
Use of proceeds:
Your SBA 7(a) loan request will be considered ineligible if, among other things, you intend to use proceeds to:
1. provide funds for speculation;
2. purchase real estate to be primarily held for sale or investment; or
3. pay delinquent state and federal taxes.
Excluded business types:
At least 19 business types are ineligible for any SBA loans. Again, you can see a full list of excluded business types on the SBA website, but here are some examples:
3. schools with religious affiliations
4. financial services businesses that are mainly engaged in lending
SBA 504 PROGRAM - ASSET ACQUISITION
The 504 program differs from the 7(a) program in that 504 loans are taken out for the purpose of acquiring tangible assets that will depreciate in the long term - i.e., land, buildings and equipment. Such assets can be easily pledged as collateral, which theoretically makes them easier to obtain. Specifically, the loans can be used for the following purposes:
1. acquisition of land;
2. land improvements;
3. acquisition of an existing building;
4. long-term leasehold improvements; and
5. acquisition of machinery and equipment.
6. 504 loans can also be used for the administrative costs in acquiring the equipment, land and buildings.
Unlike with 7(a) loans, the SBA actually lends some of the money in the 504 program. A typical 504 loan might look like this: the lender funds 50%, the SBA funds 40% and the borrower funds 10%. These amounts will of course vary depending on many circumstances.
Size requirements in 504 loans:
1. current net worth of less than $7.5m; and
2. after-tax profits less than $2.5m averaged over the past two years.
Excluded business types in 504 loans:
The business type exclusions for 504 loans are the same as for 7(a) loans, as stated above.
PERSONAL QUALIFICATIONS FOR BOTH 7(a) AND 504 LOANS
Even if your business meets the criteria described in this newsletter you will still have to be personally qualified. A lot of variables are considered by lenders. First of all, the SBA's stated policy is only to lend to people of good character. Additionally, as with any loan, lenders want to lend to people with solid credit scores. Also, they want to lend to people with experience in their chosen industry. For example, if you have restaurant experience and want to buy a gas station then the lender is less likely to fund the loan than if you were trying to buy a restaurant.
Before you make an appointment with a lender I suggest that you prepare as much as possible. Nobody ever got into trouble by being too thorough. You should obtain a current credit report, write a resume, write a business plan and complete a financial statement. Give these things to the loan officer at your first meeting and you'll be ahead of most other loan applicants.
SBA loans are one of many ways to help you finance the acquisition and/or expansion of a business. To keep this newsletter brief I purposely omitted many important details which must be considered when looking for SBA funding. It is meant only as a basic introduction to the process. I strongly encourage you to do a lot of independent research on this topic as well as consulting an experienced SBA loan officer.
Justin McInerny is also a lawyer who ran his own private practice for 13 years before taking over as vice-president of Beltway Business Brokerage in 2007. He is based in the Washington, DC suburb of Beltsville, Maryland where he helps his clients to buy and sell privately held companies.