An entrepreneur has a clever concept, a comprehensive business plan, an inspiring work ethic and a robust desire to succeed. He gets his business off the ground and has been doing well, but needs to expand to serve more customers coming through the door. As a growing business, cash is tight and credit history is limited. In such a scenario, it’s not difficult to guess what’s keeping the business owner from reaching the next level — money.
Financing opportunities tend to be limited for small and newer businesses, but your clients do have a good option. The U.S. Small Business Administration (SBA) and its flagship 7(a) loan program can keep these companies moving forward.
Although a traditional bank can serve the needs of many small-business owners who can demonstrate sustained success and a solid credit history, the SBA exists to support aspiring business owners who want to make a smaller downpayment, or those who may not meet all the requirements to be approved for a commercial real estate bank loan.
The SBA has been around since 1953, and its mission to serve the needs of America’s small businesses is just as valuable to our country’s economy today. In fiscal year 2018, the SBA guaranteed more than $30 billion to small businesses. During that time, the 7(a) program administered 60,353 loans with a combined value of more than $25 billion.
The 7(a) loan is attractive to small-business borrowers looking for a more flexible mortgage with a maximum value up to $5 million. These loans are typically used to purchase owner-occupied real estate, fund operations, buy equipment or use as working capital.
SBA loans are available to U.S. businesses with some form of invested equity that have had difficulty finding funding elsewhere. Eligible businesses can run the gamut from medical offices, pizza shops and veterinarians to machine shops, chiropractors and professional-services companies, among others.
With the 7(a) loan, a small-business owner can finance up to 90% of the property’s value and include any or all closing costs related to the loan. With an ordinary bank loan, a business owner would likely have to come up with a 20% downpayment for a loan, plus the cash for the closing costs. The 7(a) loan requires a 10% downpayment — which would mean a $100,000 downpayment rather than a $200,000 downpayment on a $1 million loan. That can make a big difference for small-business owners who need to hold onto their cash for ongoing costs related to business operations.
At the same time, the SBA provides a 75% guarantee for loans exceeding $150,000, greatly reducing the amount of risk that lenders assume. But there is a catch in that SBA loans tend to be more expensive than other types of commercial real estate loans. The SBA collects a fee that is tiered to match the size of the loan. For example, on loans up to $150,000, the fee is 2% of the guaranteed amount. For loans between $150,000 and $700,000, it is 3% of the guaranteed amount. If the loan is for more than $700,000, the fee increases to 3.5%.
With an SBA loan, the interest rates also are traditionally higher than comparable products, with the rate partly charged up to the bank. For instance, for a 7(a) loan of at least $50,000 with a repayment term of seven years or more, the maximum rate a lender is permitted to charge for a variable-rate loan is 2.75% above the prime rate. For a fixed-rate loan, the SBA publishes a monthly schedule of what is acceptable. As of late, the rate has typically been set in the range of 8% to 9%.
The SBA exists to support aspiring business owners who want to make a smaller downpayment, or those who may not meet all the requirements to be approved for a commercial real estate bank loan.
The SBA 7(a) loan, as well as other loans within the agency’s purview, are not provided by the SBA directly to borrowers. The administration partners with a number of reputable lenders around the country to make the loans.
Some of these lenders are known as preferred lending partners (PLPs), meaning they can make approval decisions on SBA-backed loans without the agency’s review. Working with a bank with PLP authority often benefits the borrower in the form of shorter turnaround times and approvals, which could save the borrower up to one month in time spent waiting.
Aside from the parameters described above, it’s up to the bank to determine borrower eligibility and they do so on an individual basis. For example, some lenders may offer SBA 7(a) loans to startups while others require a business to be in operation for at least two years before considering a loan. Some lenders will even consider borrowers who have declared bankruptcy in the past 10 years.
Most banks look for an educated, experienced borrower with clean personal credit and decent cash flow. The SBA, however, allows banks that it has designated with PLP status the freedom to approve a borrower with a slightly lower debt-service-coverage ratio (DSCR) than they would for a traditional loan. So, if your client is lacking in their DSCR, time in business or other areas, you should explore 7(a) options for your borrowers. In terms of the process, applying for a 7(a) loan is similar to applying for any other commercial real estate loan, with the exception of some additional SBA-required paperwork.
Consider this scenario: A borrower applies for a commercial mortgage, but is not a good fit. A good lender or broker will look over their application and consider an SBA-backed alternative. They would then reach out to the borrower and find out if the product is truly a fit. The lender could then start the loan process, which would include an appraisal, environmental review and completion of the required paperwork. At the same time, the borrower would have to share three years of tax returns for the business, as well as a personal financial statement and an internal profit-and-loss statement for the current year.
A success story
Here’s an example of the role SBA loans play for small-business owners. Recently, a bank had a customer, the owner of a professional-services company, who had been leasing a specialty-use building for more than 14 years.
When the landlord said he was considering selling the $2 million building, the business owner was faced with the decision to buy the building or move. After carefully evaluating the situation, he realized moving the business wouldn’t work. In order to purchase the property with a traditional commercial mortgage, however, he needed to come up with almost $500,000 for the downpayment, and he didn’t have it.
The bank suggested the business owner consider a SBA 7(a) loan that would allow him to put down only 10% and finance his closing costs as well. The business owner chose to move forward with a 7(a) loan with a variable rate for a 25-year term. He didn’t have to panic, pick up his business and move. Understandably, he was thrilled.
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With more than 60 years under its belt, the SBA continues to grow and tweak its programs to improve the borrowing experience, both for small-business owners and lenders. When looking for an SBA 7(a) loan, a good strategy for you and your client is to work with an SBA-approved preferred lender that will take the time to sit down with the borrower and walk them through the process.