Small Business Administration
As the credit markets continue to tighten, an old reliable source of financing for small businesses, the U.S. Small Business Administration (SBA) and its loan programs, is once again being looked at as a critical component in providing liquidity in the market. It is now imperative small business owners understand what is required of them to tap into this source of financing. The SBA lending market has changed dramatically over the past 120-180 days and the effect on lenders in this market has been dramatic as well. Several top SBA lenders have completely left the market with most others pulling back significantly. Losses and defaults are up and can no longer be offset with high interest rates (prime rate is at an historical low and capital costs are relatively high) or premiums earned on the secondary market, as there is no secondary market for SBA loans currently. This means SBA lenders are now approaching loans in a much more conservative manner and assessing risk instead of simply booking sufficient volume to stay ahead of delinquencies and defaults. This is being done on all loan applications, not just yours. There is going to be much more due diligence on the part of the lender and more hurdles for the borrower to jump. The days of 100% financing and fixed rate loans may be a thing of the past, but reasonable financing is still available to those borrowers willing to work a little harder and smarter.
In order for a small business owner to access capital to fund its needs, regardless of what those needs are, he or she must present as complete a package as possible to the lender. It is now incumbent upon the borrower to anticipate questions from the SBA lender and have those answers ready. The application must be complete because lenders will no longer accept applications with missing information. Additionally, several areas must be addressed in great detail within the application:
- Injection or equity
- Credit reports
- Business Plan
- Financial statements and tax returns
SBA lenders now require more “skin in the game” from borrowers as a way of passing off some of their risk to the borrowers. Borrowers now must be prepared to bring cash, and more of it, to a deal vs. borrowing it from unsecured personal lines and credit cards. Additionally, the source of the injection must be well documented by the borrower. What are those sources of injection or equity?
- Cash and savings, which can easily be documented with 3-6 months worth of bank statements. This will also give the lender some assurances as to the liquidity of the borrower and the business.
- Home equity lines of credit or HELOCs. The borrower must not only provide statements indicating the HELOC is in place, but must also account for the payments in his or her cash flow analysis.
- Retirement funds. This is gaining more popularity as a source of injection as equity in homes shrink. There are several national companies that specialize in this area. In a nutshell, borrowers can utilize retirement funds to invest in their company. This obviously has legal and tax consequences that must be fully understood, which is why it is necessary to involve a company that has experience in setting these vehicles up. Providing historical statements for these funds is typically sufficient for lenders. It should be noted that it takes time to set these situations up so the more work done at the front end the quicker closings can occur.
- Private money (friends and family). Today these sources must now provide evidence supporting the fact that they have funds available and may be required to guaranty the loan. If this is a source of injection, these people need to be aware of what they need to provide and what responsibilities they may have for your loan.
- Any derogatory comments that show up on a credit report will need to be explained regardless of how remote in time or how insignificant it may seem. Credit scores and personal credit reports carry much more weight in the underwriting process, therefore SBA borrowers must now be prepared to explain why they were late three years ago on their Sears card and why they have a $25 collection account to a doctor. In addition to the derogatory comments, lenders now look at how much availability does a borrower have on his or her revolving accounts. Are they fully drawn and are the borrowers leveraged to the hilt? Do they have significant availability to help provide liquidity to the company in difficult times? Have they tapped these accounts to provide the equity? Borrowers will need to be prepared to answer questions about these accounts, so the lender can be comfortable with the borrower’s leverage situation, but also to be comfortable with the borrower’s understanding of it as well.
Business plans are now required in almost every borrowing situation. Historically, business plans were requested by SBA lenders for start ups and little else, but that is no longer the case. Business plans not only provide the lender with information to better understand the business, but also is an opportunity for the borrower to sell his or her competence, which is now a very important piece to the decision making process to lenders. There are numerous sources of information on line, in books and with professional consulting companies to help the borrower write the plan, but it is imperative the small business owner take an active role in writing the plan. This plan should be a living, breathing document that is updated on a regular basis so the small business owner stays on top of his or her business. Understanding the business at both a macro and a micro level will not only help the owner in his conversations with the lender, it will truly help the owner understand the business and the industry. Questions to ask when writing a plan:
- Who are your customers and where do you get them?
- Who are your competitors? What are your advantages? What are their advantages? What are your weaknesses?
- What is your market? Is the market growing?
- What is your market share? Can you increase your market share? Do you need to increase your market share?
- Are you entering a new market? Why?
- Do you have key employees? Do you have a plan if they should leave the company?
- What are your margins? Can you increase prices? Can you lower prices?
These may seem like obvious questions, but a lender is not going to understand your business like you understand your business. This is an opportunity to sell to the lender – get them excited about the business, believe in the business, and make that business a loan.
Finally, borrower must provide accurate and detailed financial information. Full disclosure and complete understanding of the information is a must in today’s world. In order to get financing and grow its business, the owner must look at his or her lender as a partner and must not hold back information for fear of disclosing too much and hurting the chances of getting a loan. Ask any lender and they will tell you “Give me the good, the bad and the ugly now and we’ll look for solutions”. Lenders hate surprises and nothing will kill a loan request quicker than a surprise. Experienced lenders are able to offer solutions or work-arounds if they know about a problem or an issue.
Small business owners should be producing quarterly statements and encompassing this financial information into the business plan on a regular basis. Once again this indicates to the lender that the small business owner is on top of his/her business. Current financials allow the lender to assess the current situation and compare it to historical numbers. Current financials eliminate the need for the lender to guess as to where the business is and where it’s heading. An owner should never allow a lender to speculate if information can be provided that eliminates any speculation. An equally important benefit to the owner in having current financial statements is the ability to make changes to the business, anticipate opportunities, react quicker to conditions in the market or the economy, and adjust the long range plans of the company.
While it is easy, especially in today’s difficult credit market, to see borrowing money as an impossibility for the small business owner, that is not the case. The U.S. Small Business Administration still offers loan programs that offer small business owners financing that meets the small business’ needs. However, getting access to these funds just takes a little more time and effort than in the past.