The U.S. Small Business Administration (SBA) is a major source of financing for small businesses in the United States. The SBA's various loan programs have provided needed funding for thousands of small enterprises who were unable to secure loans from lending institutions on their own; indeed, businesses cannot solicit loans from the SBA unless they are unable to get funding independently.
Some of today's most successful businesses, including Intel, Apple, and Federal Express, were each given a much needed boost in their early days by SBA loans. This record of success, coupled with the trend toward small-business start-ups and entrepreneurship in America, has encouraged both the SBA and its lending partners to continue to expand its loan programs. The SBA has subsequently set new records in various loan guarantee categories since the mid-1990s. In fiscal year 2005 the SBA made or guaranteed $19 billion worth of loans to small businesses, the most in its history. Loans were provided to more than 80,000 small companies, 28,000 of them were start-ups.
TYPES OF SBA GUARANTEED LOANS
The SBA's 7(a) Loan Program is the most popular of the agency's programs (more than 88,000 of these loans totaling almost $14 billion were bestowed upon small businesses in fiscal year 2005). Under this program, the SBA does not actually make direct loans to small businesses. Instead, it assures the institution that is making the business loan—usually a bank—that it will make payment on the loan if the business defaults on it. Since the SBA is taking responsibility for the loan, it is usually the final arbiter of whether a loan application will be approved or not.
The 7(a) Loan Program was formed to meet the long-term financing needs of small businesses. The primary advantage of 7(a) loans is that business enterprises are able to repay the loan over a very long period of time. Ten-year maturities are available for loans for equipment and working capital (though seven-year terms are more commonplace), and loans for real estate and major equipment purchases can be paid back over as long as 25 years. The SBA can guarantee 75 percent of loans up to $750,000, and 80 percent of loans of less than $100,000. The interest rate of 7(a) loans does not exceed 2.75 over the prime lending rate.
The SBA maintains several individual loan programs under the 7(a) umbrella. These include CAPLines, LowDoc, SBAExpress, EWCP, DELTA, and an assortment of other lending initiatives targeted at specific sectors of the small business world.
Limited to $750,000, CAPLines loans are given to small businesses with short-term working capital needs. "Under CAPLines," notes the SBA, "there are five distinct short-term working capital loans: the Seasonal, Contract, Builder's, Standard Asset-Based, and Small Asset-Based lines. For the most part, the SBA regulations governing the 7(a) Program also govern this program."
The Low Documentation Loan (LowDoc) Program is a simplified version of the 7(a) loan for businesses with strong credit histories seeking less than $150,000. It combines a streamlined application process (for many loan requests, the application is only one page long) with the elimination of several bureaucratic steps to improve response time to requests. Any small business that posted average annual sales over the previous three years of $5 million or less and employs 100 or few individuals (including all owners, partners, and principals) is eligible to apply for a Low Documentation Loan. Since its inception, the LowDoc Program has proven enormously popular with small business owners and entrepreneurs.
This relatively new pilot program is only available through selected lending institutions. It makes loans of up to $150,000 to qualified businesses.
The Export Working Capital Program (EWCP) guarantees loans for qualified small businesses engaged in export transactions. It replaced another SBA program known as the Export Revolving Line of Credit Program. Most of the SBA regulations governing the 7(a) Program also govern this program. Loan maturities, however, may be for up to three years, with an option for annual renewals. EWCP loans can be extended for either single or multiple export sales.
The Defense Loan and Technical Assistance (DELTA) Program was implemented to help ease the impact of national defense cuts on defense-dependent small businesses. According to the SBA, DELTA loans of up to $1.25 million must be used to retain jobs of defense workers, create new jobs in impacted communities, or to make operating changes with the aim of remaining in the "national technical and industrial base." While listed under the 7(a) umbrella of loan programs, DELTA actually uses the 504 CDC program as well, discussed further below.
SBA MicroLoans are short-term loans of up to $35,000. In fiscal year 2005 the SBA provided $20 million worth of MicroLoans, disseminated through non-profit groups, these loans are intended for the purchase of machinery and other equipment, office furniture, inventory, supplies, and working capital. The typical MicroLoan size was $10,500 in 2005.
International Trade Loan (ITL)
The ITL provides long-term financing assistance to small businesses who are involved in international trade or who have been hurt by imports. Under this program, the SBA guarantees loans for up to $1.25 million for a combination of fixed-asset financing and working capital needs (though the working capital portion of the guarantee is limited to $750,000).
Pollution Control Program
This program extends loans to small businesses engaged in the planning, design, or installation of pollution control facilities.
The Small Business Administration's other major loan program is the 504 CDC (Certified Development Companies) Program. CDCs are nonprofit corporations established to aid communities in their economic development efforts. The 504 CDC Program is designed to provide growing businesses with long-range, fixed-rate financing (up to $1 million for qualified applicants) for major expansion expenditures in the realm of fixed-asset projects. These include: real estate purchases and improvements, including existing buildings, grading, street improvements, parking lots and landscaping, and utilities; long-term machinery and equipment; renovation of existing facilities; and building construction. Monies from the 504 CDC Program cannot be used for refinancing, working capital or inventory, or consolidating or repaying debt.
The SBA describes the program thusly: "Typically, a 504 project includes a loan secured with a senior lien from a private-sector lender covering up to 50 percent of the project cost, a loan secured with a junior lien from the CDC (a 100 percent SBA-guaranteed debenture) covering up to 40 percent of the cost, and a contribution of at least 10 percent equity from the small business being helped. The maximum SBA debenture generally is $750,000 (up to $1 million in some cases)'¶. The CDC's portfolio must create or retain one job from every $35,000 provided by the SBA."
Disaster Assistance Loans
Finally, the SBA offers these loans to businesses that have been victimized by various natural disasters (fires, floods, hurricanes, earthquakes, etc.). These loans, limited to $1.5 million and not available to firms that were insured for their losses, are available to businesses of any size that need to repair or replace facilities to "pre-disaster" condition. Economic Injury Disaster Loans are also made available to companies that suffered severe economic damage as a result of a given disaster. These loans, which are capped at $1.5 million, are meant to help businesses cover ordinary operating expenses "which would have been payable barring disaster," according to the SBA. It is worth noting that businesses can apply for either type of disaster loan assistance, but they can be awarded no more than a total of $1.5 million from the two programs unless they qualify as a major source of employment for the region in which they operate.
INTEREST RATES ON SBA LOANS
The interest rates on SBA-guaranteed loans are negotiated between the borrowing business and the lending institution, but they are subject to SBA-imposed rate ceilings, which are linked to the prime rate. Interest rates on SBA loans can be either fixed or variable.
According to the SBA, fixed rate loans are not allowed to exceed the prime rate plus 2.25 percent if the loan matures in less than seven years. If the maturity of the loan is seven years or more, however, the rate can be boosted to the prime rate plus 2.75 percent. For SBA loans totaling less than $25,000, the maximum interest rate cannot exceed the prime rate plus 4.25 percent for loans with a maturity of less than seven years (for loans that mature after seven years, the interest rate can be as much as the prime rate plus 4.75 percent). For SBA loans between $25,000 and $50,000, maximum rates are not permitted to exceed 3.25 percent (for loans that mature in less than seven years) and 3.75 percent (for loans with longer terms of maturity).
Variable rate loans, notes the SBA, may be pegged to either the SBA optional peg rate or the lowest prime rate (the optional peg rate is a weighed average of rates that the federal government pays for loans with maturities similar to the average SBA loan). Under variable rate loan plans, the lender and borrower negotiate the amount of the spread to be added to the base interest rate. Such agreements also provide for regular adjustment periods wherein the note rate can be changed as needed. Some agreements call for monthly adjustment periods, while others provide for quarterly, semiannual, or annual adjustments.
The Small Business Administration defines businesses eligible for SBA loans as those that: operate for profit; are engaged in, or propose to do business in, the United States or its possessions; have reasonable owner equity to invest; and use alternative financial resources (such as personal assets) first. In addition, to secure SBA assistance, a company must qualify as a "small business" under the terms of the Small Business Act. That legislation defined an eligible small business as one that is independently owned and operated and not dominant in its industry.
Since the passage of the Small Business Act, the SBA has developed size standards for every industry to gauge whether a company qualifies as a "small business" or not. Size standards are arranged by Standard Industrial Classification (SIC) code, but in general, the following guidelines apply for major industry groups:
- Manufacturing—A key criteria for manufacturing establishments is the size of their work force. Generally, 1,500 employees is the cut-off point for SBA consideration, but even establishments that have between 500 and 1,500 employees may not qualify as small businesses; in such instances the SBA bases its determination on a size standard for the specific industry in which the business under consideration operates.
- Wholesaling—Generally, wholesale establishments seeking SBA financial assistance should not have more than 100 employees.
- Retail and Service—Financial information is the key consideration here; ideally, retail and service industry businesses seeking SBA assistance should not have more than $3.5 million in annual receipts, although the requests of larger establishments are considered (depending on the industry). Establishments engaged in construction or agriculture industries are also evaluated on the basis of their financial reports.
The Small Business Administration also considers other factors in determining whether an establishment qualifies as a small business. For example, if a business is affiliated with another company, the owners must determine the primary business activity of both the affiliated group and the applicant business before submitting a request for SBA assistance. If the applicant business and the affiliated group do not both meet the SBA's size standards for their primary business activities, then the loan request will not be considered.
The SBA also has a number of eligibility rules that apply to specific kinds of businesses. Franchisees, for example, are often favored by the SBA because their businesses enjoy a higher success rate than do other businesses. Nonetheless, SBA officials will examine a franchisee's franchise agreement closely before extending any loan guarantees to him or her. If the officials decide that the franchisor wields so much control over the franchise's operations that the franchisee is basically an employee, then the SBA will turn down the request. Other types of businesses, such as those in agriculture or the fishing industry, are free to apply for SBA assistance, but they are directed to first look to government agencies that deal directly with their industries. Farmers, for example, are supposed to first explore loan programs available through the Farmers Home Administration (FHA), while some members of the fishing industry—depending on the nature of their need—should first consult with the National Marine Fisheries Service (NMFS). The SBA also notes that some businesses are disqualified from consideration from the outset by the industry in which they operate. Businesses that operate in gambling, investment, or media-related fields, for example, are all ineligible for SBA loans.
Finally, the SBA notes that loans that they guarantee are only to be used for specific business purposes, including "the purchase of real estate to house the business operations; construction, renovation, or leasehold improvements; acquisition of furniture, fixtures, machinery, and equipment; purchase of inventory; and working capital." Using the money for other purposes—payment of delinquent withholding taxes, acquisition of another business, refinancing of debt, and a whole host of other actions—is not allowed.
APPLYING FOR AN SBA LOAN
The chief challenge of any business seeking to secure a loan from the Small Business Administration is to convince the SBA that it has the ability to be successful in its chosen field. To do so, the small business owner should be equipped with a complete understanding of his or her operation (whether existing or proposed) and the benefits that a loan, if granted, will bring to the business. Of course, it is also necessary to effectively articulate this information to the SBA. Business owners disseminate this data through a variety of documents.
Principal documents that should be submitted by the entrepreneur who hopes to start a new business include: resume (and resumes of any other key people involved in the proposed enterprise); current financial statement of all personal assets and liabilities; summary of collateral; proposed operating plan; and statement detailing revenue projections. Perhaps the most important document, however, is the loan request statement itself, for it is this document that should detail all aspects of the proposed business. For established business owners seeking an SBA loan, the most important documents—besides the loan application—are the company balance sheet, personal financial statements, and business income statements. Consultants urge small business owners to be both careful and realistic in preparing these records. They also caution entrepreneurs and small business owners not to distort figures or facts in their presentation. The SBA does not look kindly on misrepresentations in financial statements or any other part of the loan application.
The Loan Application
The SBA loan application form serves to summarize much of the information detailed elsewhere in the total application package. Applicants are directed to furnish basic information about themselves and their businesses, including personal information (full legal name, street address); basic business information (employer ID number, type of business, number of employees, banking institution used); names and addresses of management personnel; estimated business expenditures and costs (including details on the SBA loan request); summary of collateral; summary of previous government financing; and listing of debts.
The SBA loan application form also provides a complete listing of the various other items of information that must be provided for a business's application to be considered. These include a personal history statement; personal and business financial statements; business description; listing of management personnel; equipment list; cosigners; summary of bankruptcies, insolvencies, and lawsuits (if any); listing of any familial relationships with SBA employees; subsidiaries, either proposed or in existence; franchise agreements; and statements of financial interest in any establishments with which applicant business does business, if applicable.
Cohen, William. The Entrepreneur and Small Business Problem Solver. Second Edition. Wiley, 1990.
O'Hara, Patrick D. SBA Loans: A Step-by-Step Guide. Wiley, May 2002.
"SBA Loan Approvals on Record Pace." Mississippi Business Journal. 25 April 2005.
U.S. Department of Homeland Security. "Emergencies and Disasters: Hurricane Katrina, What Government is Doing." Available from http://www.dhs.gov/interweb/assetlibrary/katrina.htm. Retrieved on 8 May 2006
U.S. Small Business Administration. SBA's 2005 Performance and Accountability Report. Available from http://www.sba.gov/2005PAR.pdf/. Retrieved on 8 May 2006.