Step-by-Step Guide to Raising Capital from Banks & SBA Lenders

Transcription

1 Step-by-Step Guide to Raising Capital from Banks & SBA Lenders

2 Legal Notices All rights reserved. No part of this publication may be reproduced in any form or by any means graphic, electronic or mechanical including recording, photocopying or by any other information storage or retrieval system, without the written consent of the publisher. This publication is sold as an educational reference only. While all attempts have been made to verify information provided in this publication, neither the author nor the Publisher assumes any responsibility for errors, omissions or contrary interpretation of the subject matter herein. This publication is not intended for use as a source of legal or accounting advice. The Publisher wants to stress that the information contained herein may be subject to varying state and/or local laws or regulations. All users are advised to retain competent counsel to determine what state and/or local laws or regulations may apply to the user s particular business. The purchaser or reader of this publication assumes responsibility for the use of these materials and information. The author and Publisher assume no responsibility or liability whatsoever on the behalf of any purchaser or reader of these materials. We expressly do not guarantee any results you may or may not get as a result of following our recommendations. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders

3 Table of Contents Introduction... 1 What is a Bank Loan?...1 Debt versus Equity... 2 Pros & Cons of Debt Capital... 3 Overview of the Key Types of Loans... 5 Home Equity Loans... 5 Lines of Credit... 5 Traditional Loans... 6 Small Business Administration (SBA) Loans... 6 Important Elements of a Loan... 7 Collateral...7 Prime Rate...7 Credit Rating... 8 Principal and Interest... 8 What Lenders Look for...9 Revenue Streams or Income... 9 Your Credit History & Public Record...10 Debt To Net Worth Ratio Location Establishing a History with Your Bank...12 Being Professional...12 Key Types of Loans Home Equity...13 How much can you raise from a home equity loan?...14 Business Line of Credit Traditional Loan...16 Loans From the Small Business Administration SBA Loans: What Are They?...18 Who Is Eligible For SBA Loans?...18 What Are The Different Types of SBA loans?...19 Step-by-Step Guide to Raising Capital from Banks & SBA Lenders

4 7(a) Term Loans...19 CDC/504 Term Loans Microloans...21 Disaster Recovery Loans...21 Special Purpose Loans ARC Loans SBA Loans vs. Traditional Bank Loans What s The Difference? Interest Rates Terms of Loans Government Backing on Defaults...27 Types of SBA Lenders and Loan Forms Types of SBA Lenders Low Doc Loans SBA Express Loans Patriot Express Loans...31 Step-by-Step Plan for Getting an SBA or Bank Loan Step One: Invest Your Own Equity Step Two: Assess Your Needs Step Three: Prepare the Necessary Documents Step Four: Find The Right Bank Step Five: Prepare To Make & Negotiate The Deal...35 Step Six: Grow Your Business Appendix A: Largest Lending Institutions in the U.S Appendix B: Preparing Your Business Plan...38 Overview The 10 Sections of Your Business Plan Your Executive Summary The Company Analysis Section Detailing Your Industry Size and Trends...41 The Customer Section Competition The Marketing Plan Partnerships The Operations Plan...51 The Financial Plan The Management Team Step-by-Step Guide to Raising Capital from Banks & SBA Lenders

5 Introduction What is a Bank Loan? A bank loan is a sum of money that is given to an individual or business that must be repaid. This guide focuses exclusively on business loans, and how you can attain these loans to start and/or grow your business. There are several types of bank loans relevant to your business, all of which will be covered in detail in the following sections. To give you a perspective into the lending market for small businesses, the government agency responsible for small business lending has $45 billion in loans outstanding, which still only makes up a fraction of all small business loans. The government strongly supports lending to small businesses through the Small Business Administration (SBA). It does this by guaranteeing a portion of your bank loan with government funds. Doing this lowers the risk for the lender. We will cover this process in more detail later. However, before making the decision to take out a loan to fuel your business, we should first clearly identify where a bank loan falls into your many funding options. Most likely, you have decided to raise capital because of a need to grow your business, whether it has to do with early stage funding or an expansion of your operations. By choosing a loan, you are raising capital through debt financing. This is different from equity financing in many ways. The decision of financing through equity versus debt has much to do with the current stage of your business, and to a lesser extent with the goals that you want to achieve. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 1

6 Debt versus Equity Raising equity capital, unlike debt capital, is when someone invests in a company in return for ownership through shares in the given company. This is generally the case with received funding from venture capitalists and angel investors. The major difference between venture capitalists and angel investors is that venture capitalists generally operate a fund from which they take portions and invest it in firms who they believe have a high chance of succeeding. Angel investors are individuals who spend their own money to invest in a business. The money raised from either of these two sources generally does NOT need to be paid back. Rather, the investor generally receives a return on their investment when there is a liquidity event. This means that the company cashes out such as being sold to another company or having an initial public offering or IPO. Note that a liquidity event is also known as an exit. With debt capital, or traditional bank loans, there is no transfer of ownership in the company. The tradeoff is that you owe the bank every dollar borrowed (the principal) plus the interest payments. As you might imagine, equity capital is much riskier to investors than debt capital. With debt capital, lenders will receive interest and principal payments from the businesses they lend to, and earn perhaps 10% on their money with a relatively low risk profile. That is, due to their review process, the lenders feel that there is a high likelihood that the company will be able to repay the loan and meet its interest payments. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 2

7 Equity capital is very different since the likelihood of a liquidity event is relatively low. However, when this does happen, investors can receive 10 times, 100 times or even 1,000+ times their money back. Note that with equity investments, investors also believe that there is a strong likelihood that their investments will succeed, but they do understand that there is more risk involved than with most debt investments. Pros & Cons of Debt Capital The major negative to entrepreneurs of debt capital is that they generally go towards low risk businesses. Bankers look for businesses that have the highest probability of paying back the loan. More importantly, businesses also have to be able to meet the monthly interest payments on the loan. What do this mean for your business? Those businesses in the design or startup stage will have a harder time financing through debt because they cannot meet the immediate interest expenses. In other words, if you have no income because your product or service isn t finished yet, it is less likely (but still very possible) for you to be funded by a bank. Most banks will ask for a multi-year operating history in order to evaluate how risky your business is. Depending on your current position, this will either help ensure you a loan if you have healthy revenue streams, or make funding through debt more difficult. However, there are still ways for early stage companies to get bank loans as will be explained in this guide. Also, there are several positives in financing through debt capital. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 3

8 The major thing that most entrepreneurs have trouble with is giving up partial ownership of their company. Through a traditional loan, you can continue to put your vision forward in the manner you see fit. You will not have to worry about pleasing your investors and meeting their exit strategy. Since you have not given up partial ownership in your company, you also don t have to share the proceeds with investors should your company be acquired or go public further down the road. Moreover, the effort it takes to acquire equity funding far exceeds the effort required to apply for a bank loan. Thorough business plans and presentations, as well as a lower chance of being invested in are all headaches of those seeking equity capital. You could potentially save valuable time and effort when financing with a bank instead of with equity. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 4

9 Overview of the Key Types of Loans Now is a good time to introduce some of the important loans for small businesses. There are several types of loans that can be used for your business. The core types include home equity loans, lines of credit, traditional bank loans and the more specialized SBA loans. Each of these will be covered in more detail in the following sections. Home Equity Loans A Home Equity Loan is a loan that is secured by the home in which the business owner lives. These loans typically have reasonable financing rates, and are much more affordable than financing with credit cards. The reason for this is because they are secured by collateral, which is a valuable asset owned by the you, the borrower. In the case of Home Equity Loans, your house is the collateral that is roughly equal in value to the loan taken out. Because the banks now have an insurance policy, they can offer you the loan at lower rates. Should you default however, or not meet your payments on the loan, the bank will have the opportunity to repossess your home and sell it in order to recoup its money. Lines of Credit Your business line of credit is the amount of money a bank makes available to you. More importantly, it functions much like a credit card where you only pay interest on the actual amount borrowed which may be less than the total amount the bank is willing to lend you. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 5

10 This type of loan typically allows you to use your loaned funds for any business activity, while some traditional bank loans have restrictions on what the capital can be used for. Traditional Loans Traditional bank loans are what most people think of when they picture receiving funds from a bank. Essentially, these loans are deposited in full into your bank account, and you then pay the interest on the entire amount borrowed. Traditional bank loans will commonly be secured, or backed by collateral, have low interest rates and may be issued for specific purposes only, such as a loan to meet short term expenses only. Small Business Administration (SBA) Loans SBA Loans are a key source of financing for many small businesses. They are a bit more complex than most other loans and will be outlined in detail in their own section in this guide. An important characteristic of SBA loans, or small business administration loans, is that they are backed by the government. What this means is that the government, alongside the SBA-authorized bank who makes the loans, bears much of the risk of the entrepreneur defaulting on paying back the loan. Because of this the banks have less to worry about and are much more likely to lend money through the SBA program. The main purpose behind SBA loans is to drive small business growth, and give entrepreneurs like yourself a chance to launch and grow your business. Many businesses in their early stages will rely on SBA loans to fund their operations. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 6

11 Important Elements of a Loan Collateral Collateral is an asset that is pledged as a security for debt. It covers the lender s investment in case you can not meet your payments. If this occurs, the collateral will be sold to complete the rest of the original contract. More specifically, there are four types of collateral recognized by the Uniform Commercial Code: trade goods, paper such as title documents, intangibles, and business proceeds (cash). For businesses, the actual item being financed may also serve as your collateral, such as inventory, machinery or accounts receivable. Prime Rate The prime rate is an index of lending rates from major banks which they use to charge their most creditworthy customers. It is the base for judgment on any given loan. Synonyms include base lending rate and reference rate. The prime rate is published regularly in the Wall Street Journal or can be easily found online. If you don t have perfect credit you are still tied to the prime rate because lenders will charge a premium in addition to the prime rate to cover their risk. In other words, the rate you are quoted for a particular loan may be slightly above the prime rate. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 7

12 The actual rate prime rate depends on the Federal Reserve s decision to raise or lower interest rates for short term borrowing. The prime rate is an industry standard. It gives borrowers like yourself an idea of what a potential loan will cost. Credit Rating A credit rating assesses either an individual s or a company s credit history and often focuses on your past ability to repay loans and pay bills on time. Your credit rating, also known as credit score or FICO score, is a number between 300 and 850, with 850 being the best. It comes compiled on your credit report, along with your identifying information, public record, and overview of credit history. Principal and Interest When you take out a loan, the total amount given to you by the bank is the principal. Depending on the term, or duration of the loan, you will have a certain amount of time before having to repay this amount. The interest, on the other hand, is the monthly payments that you have to make in relation to the principal (oftentimes the monthly payment includes the interest plus part of the principal). Usually you will see the interest advertised as a percent per annum, such as 8%. This means that each year, you will pay 8% of the principal amount to the bank as a fee for being able to borrow their money. This fee is the interest payment. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 8

13 What Lenders Look for As with any loan, bankers will want to see your income and credit history. They also will want to make sure that you have a healthy debt to net worth ratio. In addition, banks will consider your location, your history with the bank and your professionalism in their decision-making process. These issues are all discussed below. Revenue Streams or Income Unlike with venture capitalists and angel investors, bankers don t necessarily invest in your business idea. They do not go out of their way to identify businesses that will be successful down the road, hoping for 10 or even 100 times the return on investment. Instead, they seek businesses that promise a relatively safe return. What many bankers place value on is you knowing your businesses inside out. Be confident and have every document lined up to support what you say. This is where a business plan will greatly help you, as a strong support tool that acts as a backup expert. Also come prepared with anything else you believe may help convince bankers of your ability to repay the loan. In specific, most lenders seek financial statements and projections that show you will able to meet your future obligations such as interest and principal payments. The problem is that start-up businesses don t have a lengthy financial record. But don t worry! The government has stepped in and understands the obvious conflict of interest between banks and start ups. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 9

14 Since small business is considered by some to be the backbone of any economy, the government established the SBA to take some of the risk away from the banks, allowing them to lend to startups and foster overall economic growth. Beside your revenue streams, banks will want to see your credit history and review your debt to net worth ratio. Your Credit History & Public Record Credit bureaus collect information on your debt and whether or not you pay your bills on time. They process all of this information and compile it onto a document known as a credit report. These bureaus weigh all of this information, and calculate a number between 300 and 850, 850 being the best. This number is known as your credit score and gives lenders a good idea of where you stand. In more detail, your credit report has your identifying information, credit history and public record. Identifying information just lets the lender know and double check that he is dealing with the correct person. It entails information such as your name, address and social security number. Your credit report and public record are the two key items that will have an influence on the banker. The credit report shows a lot about your banking and debt history. It covers whether or not you pay your monthly bills on time and any past loan obligations. It reveals when you opened your bank accounts and if you closed them or if they were closed due to other reasons. Other important things included are your current credit limits and how much outstanding debt you have. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 10

15 On the other hand, your public record covers things such as any foreclosures or bankruptcies you incurred. Also any legal judgments that may impact your chances of receiving a loan are included, such as failure to pay child support. All of these records impact your overall credit score. The federal government entitles you to one free credit report per year. You may also purchase them from independent organizations, such as Fair Isaac, should you need more than one per year. Debt To Net Worth Ratio Lenders want to look at how burdened you are before making the decision to lend to you. If you are too deep in debt already, they will not want to extend a loan offer to you. High debt to net worth ratios (your debt to net worth ratio equals the liabilities of your business divided by the total shareholder s equity) are a signal to the lender that you are anything but liquid and most likely won t be able to make your payments. Remember, banks are looking for low risk investments. An acceptable debt to net worth ratio depends on the market and also changes from person to person. With home equity loans for example, an 80% debt to net worth ratio is about average. Location A big misconception held by many entrepreneurs and business owners is that they if they want a large amount of capital, that their only option is to court the larger banks. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 11

16 In actuality, local banks can be the best friend of a growing company. It s important to remember that smaller banks, like larger banks, need to make investments. And local banks focus on lending money to local companies. Establishing a History with Your Bank Banks (like equity investors) like to invest in business owners with which they have a pre-existing relationship. This relationship breeds trust and confidence that the business owner will spend their money wisely. As such, it s a good idea to establish a credit history with your bank six to twelve months BEFORE you need the loan. Even if you simply take out a $5,000 loan and show that you are able to make payments each month for a year, your business will be more likely to receive the larger loan you seek later Being Professional As with any business loan, whether it is an SBA or a traditional bank loan, make sure to have all of your documents prepared and present yourself in a professional manner. Your punctuality and organization goes a long way in making a strong impression. The documentation required and the process of applying for each loan is outlined below. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 12

17 Key Types of Loans Home Equity A Home Equity Loan is a loan that is secured by the home in which the business owner lives. Home equity loans can often provide a substantial amount of capital to the business. Unlike credit cards, the interest rates for home equity loans are much more reasonable. In fact, average home equity loan rates are currently only half the rate of average credit card rates. In addition, home equity loans are often tax-deductible. However, because they are secured, these loans place substantial risk on the business owner. Specifically, the business owner s house becomes collateral for the loan, and if the owner defaults on the loan, their house becomes the property of the bank. Home Equity Loans make sense if the business owner expects a return on their dollars in a short period of time, perhaps within 180 to 365 days. Also, make sure you put the entirety of your home equity loan to use. Don t borrow more than you need to grow your business. You don t want to be paying interest on money that you are not using. Alternatively there is a home equity line of credit, or HELOC. Opening up a HELOC allows you to use cash made available from the bank up to a certain limit. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 13

18 They function similar to a credit card, however at a much lower rate. Currently the national average for these types of loans is approximately 6%. Home equity based lines of credit are, simply put, a secured line of credit. These types of loans require more explanation and are covered in full in the section below. How much can you raise from a home equity loan? The amount you raise from a home equity loan largely depends on your debt to net worth ratio or more specifically the LTV, or loan to value ratio. Your loan to value ratio is the ratio between the value of your home, and the loan or mortgage that you still have outstanding on your home. Lenders typically try to keep this ratio at 80%; meaning that you can owe as much as 80% (but not more) of the value of your home in debt. For example, if you have purchased a home that s worth $1 million and received an $800K mortgage, you would have had an LTV ratio of 80% when you took out the mortgage. Let s say you now decide to apply for a home equity loan. The lender will appraise your home and weigh it against your debt outstanding. The value of your home has probably changed since you purchased it, and thus needs to be priced fairly at market value. The lender will now take your existing mortgage, add the new home equity loan to it, and aim for an 80% LTV ratio. For example, if you still owe the $800K on a home that has now appreciated to $1.2 million in value; you will most likely be able to get a home equity loan. Since most lenders feel comfortable with an 80% LTV ratio, you could get an equity loan of $160K. This is because the previous balance owed of $800K plus the new loan of $160K equals 80% of $1.2 million. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 14

19 Some lenders may offer you more equity, exceeding the 80% LTV ratio. However, these types of loans depend even more on your credit history, and will typically have much higher rates. Business Line of Credit A business line of credit is an amount of cash that a bank or other financial institution makes available to you. These lines of credit are tremendously valuable for small business, particularly for meeting immediate and short term needs. For instance, if your company is accepted for a $100K line of credit, you have access to the full $100K of capital, but you only pay interest on the precise amount that you actually borrow. Additionally, if you are able to pay off the full balance on your monthly billing statement, you will not incur any interest charges at all. So, for example, if you have a $100K line of credit but are only using half of it, you only pay interest on $50K and not the full $100K. As such, business lines of credit are similar to credit cards. You have access to funding up to your limit, in this case $100K, but only pay interest on the amount of funding that you actually use. An additional benefit of lines of credit is that you are generally allowed to use them for anything your business desires, such as for working capital, advertising, etc., while many other types of loans have specific parameters such as requiring you to use the funding for capital expenditures such as purchasing equipment. The flexibility of a line of credit allows a small business to take advantage of unexpected opportunities as they present themselves. They also provide a Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 15

20 measure of security, in the event that unanticipated expenses or liabilities are incurred. Banks are the most common place to get lines of credit. When determining which companies they will offer credit to, banks often examine your business financial records and tax returns for the last 2 or 3 years. These lines of credit are generally not secured, meaning your reputation is your collateral; it will be difficult for the bank to seize your personal assets in the event of default. Lines of credits can be made with and without collateral and are known accordingly as secured and unsecured lines of credit. Secured lines of credit can have interest rates as low as the prime rate, which is approximately set at 3.25%. Unsecured lines of credit typically have interest rates ranging from prime plus 1.5% to prime + 10% depending on the credit history of the borrower. Most major banks provide lines of credit for small businesses, as do smaller local lenders. A simple internet search of small business line of credit or a quick look at any bank s web site will lead you in the right direction. Traditional Loan Bank loans are similar to lines of credit, except that you pay interest and are given all of the capital at once. So, with a $100K line of credit, you have access to the full $100K, but don t have to use it. That is, you can simply not access the funds from your bank, and you don t pay anything for the funding you don t use. But, with a $100K bank loan, the bank or other financial institution gives you $100K to deposit into your business bank account and you pay interest on all $100K whether you use it or if it simply sits in your bank account. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 16

21 These traditional bank loans are a great source of inexpensive capital, but only for specific types of businesses, mostly mature businesses. With regards to rates, with good solid credit, business loans are made at a relatively low rate. With weaker credit, slight premiums are assessed. Moreover, business loans have tighter restrictions on what the capital can be used for. Banks will typically lay out the conditions of the loan, and offer packages for specific types of investments. Regions Financial for example, the third largest small business loan provider, offers its clients capital for either new building construction, modernizing and renovating existing buildings, purchasing machinery or vehicles, refinancing existing debt, or to fund short term working capital. These restrictions should be viewed more as a management tool rather than a burden to you and your business. By restricting the use of the loan, it reduces the risks banks take of running into bad management. It also serves as a vehicle for you to improve management techniques while freeing up valuable time. These loans are typically only available to mature businesses because bank loans tend to require extensive documentation in order to be approved. And often this documentation includes the past three years of your business operating results. Obviously, if your business is a startup or less than three years old, you thus don t qualify. Also most traditional business loans must be secured with either business assets such as land, property, equipment or inventory, or personal collateral such as the business owner s home. As such, newer businesses should seek SBA loans, which are detailed in the next section. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 17

22 Loans From the Small Business Administration The Small Business Administration (SBA) is a division of the United States federal government. The SBA seeks to assist and support American entrepreneurs. They do this through a variety of programming; of particular interest to us are their loan programs. The Small Business Administration exists to help YOU raise capital! SBA Loans: What Are They? The SBA has arranged capital for small businesses in an amount exceeding $208 billion since the 1950 s. They continue to do this today, with a variety of different types of financing to support the various needs of businesses. These loans do not actually come from the SBA. There is an existing network of banks that cooperate with the SBA to extend these loans. They are unique because they are backed in part by the SBA. This means the bank is insured in case somebody is unable to repay them. This encourages banks to give out more loans and to do so with more favorable terms to entrepreneurs. Who Is Eligible For SBA Loans? In order to get an SBA loan, the applicant must meet certain eligibility standards. They vary in specifics from loan to loan, but the following criteria hold true in most cases. The primary consideration in the SBA loan decision process is the business ability to repay the loan from the cash flow of the company. Other considerations revolve around the business and the business owner. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 18

23 Regarding the business, it must operate in the United States or its possessions. Also, the business must not be engaged in illegal activities, loan packaging, speculation, multi-sales distribution, gambling, investment or lending. Other considerations revolve around the business owner. Specifically, the lender wants to make sure that the owner has good character, has management capability, can offer collateral, and has contributed equity into the business. With regards to the owner s equity contribution, usually (and this is not always the case), the SBA wants to see that the owner has invested over 25% of the requested funds into the business out of their personal funds. Why? Because such business owners would be much less likely to walk out on the business in times of trouble. Note that if you do not personally have the funds to finance 25% of your capital needs, you might need to seek friends and family or angel financing before requesting an SBA loans. Or, you can finance the early stages of the business with credit cards, and re-invest the earnings (which is now your personal capital) into the business. What Are The Different Types of SBA loans? There are several different types of SBA loans available. They include 7(a) Term Loans, CDC/504 Term Loans, Microloans, Disaster Recovery Loans, Surety Bonds, and various types of Special Purpose Loans. 7(a) Term Loans This is the most common type of loan backed by the SBA. When an entrepreneur applies to a participating bank for a loan, the bank reviews their application and applies for a guarantee from the SBA. If the SBA approves the loan, it means they Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 19

24 will share the risk on that loan and be willing to cover part of the bank s loss in case the borrower defaults. 7(a) Term Loans can be used for purchases of fixed assets and properties, materials, as working capital, to refinance other debt, or for various other purposes. The SBA secures between 75% and 85% of the loan, at a rate slightly above the prime rate (2-3% above, usually), on principals of up to $2,000,000, for terms ranging from 7 to 25 years. Borrowers must meet certain requirements to qualify for a 7(a) Term Loan. They must qualify as a small business in terms of income and number of employees and be a for-profit business. The definition of small varies by industry. They must also have operating cash flow to show that they have repayment ability. Certain types of businesses are ineligible, including religious/charitable organizations, businesses involved in gambling, illegal activities, pyramid schemes, lending, speculative or real estate investing, and businesses owned by someone in prison or on parole. Special 7(a) Term Loans are available for businesses involved in the creation of pollution control facilities. CDC/504 Term Loans Certified Development Company (CDC) loans are another common type of SBA loan used for purchases or improvements of large fixed assets such as properties or equipment. In this special type of loan, 50% of the money comes from a bank, 40% comes from a CDC, and 10% comes from the recipient of the loan in the form of equity. Maximum principal for CDC/504 loans ranges from $1,500,000 to $4,000,000, depending on the type of project. Interest rates are tied slightly above the 5- and Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 20

25 10-year U.S. Treasury Rates, and loan terms are generally 10 years or 20 years. There is a 3% fee attached to the loan as well, but this is usually paid with the funds provided by the loan itself (i.e., only 97% of the loan amount is given to you). Collateral is required from both the owner of the business and by the actual asset being purchased. Businesses with a net worth of $7,500,000+ or with average net income of $2,500,000 during the previous two years are ineligible, as are speculative businesses and rental real estate organizations. Microloans A slightly different funding model is used by the SBA for microloans. Instead of a bank providing funds with a promise of SBA backing in the event of default, the SBA here provides money to local non-profits who loan it out at their discretion. Microloans vary a great deal because they are administrated and regulated entirely at the local level. Therefore, collateral requirements, terms, and rates all vary. However, they are limited to $35,000 with a term of 6 years. Interest rates are generally between 8 and 13%, and the average loan size is $13,000. Another key difference here is that the local non-profits intermediaries are required to provide business training for their borrowers. Disaster Recovery Loans These are specialized loans available only for victims of natural disasters, such as hurricanes or floods. They come in two forms: real property loans and personal property loans. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 21

26 Real property loans are limited to $200,000 and must be used to bring damaged property back to its original condition, but may not be used for upgrades. Personal property loans are limited to $40,000 and must be used to replace nonstructure items, but not luxury items. Rates charged for these loans are based on the applicant s creditworthiness. Applicants who have difficulty receiving credit from normal lending institutions have their rate capped at 4%, while creditworthy individuals are capped at 8%, with term loans of up to 30 years. While these loans are generally used for restoring personal property or personal real estates, it is possible that the personal property in question fulfilled a business function as well. Special Purpose Loans A variety of Special Purpose SBA Loans exist. Export Working Capital Loans. These loans are meant to assist small businesses who need short-term funds to sustain their export sales. The SBA guarantees the loans at 90% for up to $1,500,000, though loans are available for up to $2,000,000. Businesses must meet small-business criteria (< 500 employees for manufacturers, < 100 for wholesalers) and must have existed for at least one year (some exceptions apply for experienced managers). Rates are determined by lenders; the term is usually 12 months. Export Express Loans. These loans are used to expand export businesses in a variety of ways. In some cases, a loan of up to $250,000 can be made available in 24 hours or less. Similar size restrictions apply as to recipients of Export Working Capital Loans. Interest rates and collateral policies are determined by Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 22

27 individual lenders. The SBA guarantees between 75% and 85% of the loan, depending on its amount, and terms range from 5 years to 25 years, depending on use of funds (longer terms are used for real estate). International Trade Loans. These loans are designed to enhance the competitive position of businesses who export goods or have been negatively affected by an importer. They may only be used for fixed assets; use of funds as working capital is prohibited. Loans are available up to $2,000,000 and the SBA will guarantee (under certain circumstances) up to $1,750,000. Rates are determined by the lender but are capped at 2.75% above the prime rate. A lien/mortgage is required on the property purchased by loan funds as collateral. Terms range from 10 to 25 years, depending on use of funds (longer terms are used for real estate). CAIP. The CAIP program provides funds to pay for various fees associated with 7(a) and CDC/504 loans. These funds are restricted they are only distributed in areas that were negatively affected by NAFTA. CAPlines. The SBA provides lines of credit to help fund working capital for small businesses. These specialized lines of credit are available as seasonal lines, contract lines, builders lines, standard asset-based liens, and small-asset based lines. These are limited to $2,000,000, or $200,000 in the case of small-asset based lines. There is a high degree of variability in loan conditions, but these loans generally have terms of around 5 years, rates based on the prime rate, and require a guarantee from anyone holding 20% equity or higher in the business in question. ARC Loans In response to the economic crisis of 2008/2009, the SBA created a new type of loan called the America s Recovery Capital loan, or ARC. It is specifically Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 23

28 designed for specific purposes: to help existing viable businesses that were profitable in one of their past two years but are currently experiencing distress. These are emergency funds in the form of deferred loans. The funds are dispersed to you over a period of up to 6 months but you are not required to make any payments until 12 months have elapsed since you were funded. Payback terms are up to five years. The maximum loan principal is $35,000. There are no fees to the borrower, the government guarantees 100% of the loan to the SBA (but not to you remember, you re not off the hook), and the interest rate is prime plus 2%. ARC loans can be used to refinance existing business-related debt. For example, if you can no longer make payments on a home equity loan that you used to fund your business, you can take out an ARC loan to cover it until your business is generating more cash for you. In order to qualify for an ARC loan, you (a) must not have other SBA loans, (b) must have been profitable at some point in the past two years, and (c) must be able to prove you are experiencing financial distress. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 24

29 SBA Loans vs. Traditional Bank Loans What s The Difference? The primary difference between an SBA loan and a traditional bank loan is the role that the government plays. In a traditional bank loan, there are only two parties involved: the bank and your business. They loan you money and you pay them back over a period of time. But with an SBA Loan, there are three parties involved: the bank, your business, and the Small Business Administration. Similarly, the bank loans you money, and you pay them back over a period of time. The government steps in by issuing a guarantee to the bank for a certain percent of the loan usually around 75%. This means, if the business fails to pay back the loan on time (called defaulting ) the Small Business Administration will pay the bank to make up the difference. The business is not off the hook for the loan, but in the meantime the government is reducing the bank s risk. Interest Rates Interest rates are a key difference between traditional bank loans and SBA Loans. In a traditional bank loan for a small business, the interest rate is often determined by the prior success history of the business and by the owner s personal credit rating, along with other details of the loan. This means it will vary from bank to bank and with other circumstances. SBA loans, on the other hand, are usually pegged to the prime rate. This means the SBA rate will be a fixed number of percentage points above it. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 25

30 Type of SBA Loan CDC/504 Notes On Interest Rates Tied to 5- and 10-year US Treasury Note rates Microloans Negotiated, generally 8% to 13% Disaster Recovery ½ of your quoted rate from normal lenders, capped at 4% Export Working Capital Negotiated and capped, can be fixed or variable Export Express Negotiated and capped. Varies International Trade Loans Negotiated, capped at prime for loans of $50K with terms over 7 years CAPlines Same as 7(a) rates Maximum 7(a) Loan Rates Term less than 7 years Term more than 7 years Under $25K $25K to $50K Over $50K Prime % Prime % Prime % Prime % Prime % Prime % Terms of Loans SBA loans come with a variety of terms, depending on what kind of loan and what it will be used for. Choose a loan with the best term to fit your business needs. Term Lengths Real Estate Machinery and Equipment Working Capital General or Other 7(a) 25 yrs 25 yrs 7-10 yrs 7-10 yrs CDC/ yrs yrs - - Microloan yrs Disaster 30 yrs 30 yrs - - Recovery Export mos. - Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 26

31 Working Capital Export 25 yrs yrs 5-10 yrs 7 yrs Express Internation 25 yrs yrs - - al Trade CAPlines yrs Traditional bank loans, on the other hand, vary a great deal from bank to bank, depending on the borrower, the business, the bank, the economy, and any number of other factors. Government Backing on Defaults The most important feature making SBA loans unique is their government backing. This functions as a kind of insurance for the bank even if a business fails, they are assured of being reimbursed for a fixed of the loan, coming from the government s pockets. This doesn t mean the borrowing business is off the hook. While there are some stories of SBA debtors defaulting and being forgiven outright, it is not wise to count on that happening. Most SBA loans will require the business or the owner of the business to put up some form of collateral it could be your house, your retirement fund, your yacht, or another asset. If the deal you sign with the bank involves collateral, and your business defaults on the loan, the bank has the right and may choose to come after whatever assets were specified as collateral. After pursuing collateral, then the bank receives the remainder of the loan from the SBA. Traditional banks loans differ because they have no government backing at all. This means that the loan is entirely secured by collateral, and you can be 100% assured that the bank will be coming after your personal assets if you default. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 27

32 Also, it is likely that banks will demand more collateral for a traditional bank loan, because that is their sole source of security on the loan. The following charts display the values of various assets as collateral for SBA and bank loans. House Stocks and bonds Certificates of Deposit Receivables Assets with High Value as Collateral Asset Value 80% (75% for traditional bank loans) of market value, minus remaining mortgage value 50% to 90% of market value 100% of value 50% of 90 days worth (75% for traditional loans) Trucks/Industrial Equipment Assets with Some Value as Collateral Asset Value 50% of net value (depreciated) Furniture/Fixtures 50% of net value (depreciated) Misc. Other Assets 10%-50% of market value Cars Assets with No Value as Collateral Asset Value None Office Equipment None Perishable Inventory None Jewelry None Mutual Funds None IRAs None Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 28

33 Types of SBA Lenders and Loan Forms Types of SBA Lenders There is more than one type of SBA bank lender. In fact, there are three levels of participating banks. Different types are afforded different privileges by the SBA. This will affect your choice of who to borrow from, as there are approximately 22,500 SBA lenders in the U.S. to choose from. General lenders form the majority of SBA participants. These are licensed SBA lenders who have experience and are deemed trustworthy by the SBA. There are approximately 21,200 of such lenders in America. CLP lenders participate in the Certified Lender Program. The SBA has recognized these institutions as successful lenders and therefore delegates more responsibility to them, allowing them to perform all financial analysis of the transaction. They receive priority processing from the SBA. Because of this, they act more independently from the SBA and are able to process loans more rapidly than non-certified lenders. There are approximately 850 lenders in this program. PLP lenders participate in the Preferred Lender Program. They have been designated as the most successful lenders and are allowed to make their own decisions regarding whom to loan money to, without consulting the SBA first. This means that their loan processing times are the shortest and you can get your money sooner. This also means that, in the event of a default, they agree to seize the borrower s assets before they seek reimbursement from the SBA. There are only around 450 of these lenders in the United States, but they offer very rapid turnaround often Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 29

34 within a day or two. Representing 2% of SBA lenders, they issue more than 20% of SBA loans! If you need cash in a hurry, your best bet is to work with a CLP or PLP lender. Low Doc Loans A special form of loan offered by the SBA is the LowDoc loan, short for Low Documentation Loan. In an effort to streamline the process of giving out loans, the SBA offers these loans with simplified paperwork requirements. The details and specifics are generally similar to that of SBA 7(a) loans. Generally, for startups, the paperwork is minimal, limited to financial statements, analysis, projections, business plans, and proof of collateral. Existing businesses require the same financials along with personal and business tax returns, plus a trivial number of other documents. These loans have a turnaround within 36 hours. SBA Express Loans This other special form of loan is focused on rapid turnaround time. The SBA guarantees only 50% of these loans, and so interest rates are higher (prime rate + 4.5% for principals greater than $50,000;, prime rate + 6.5% for principals less than or equal $50,000). These loans move through the system more quickly because they are handled mostly at the lender s level. These loans are often revolving loans, meaning they can be withdrawn, repaid, and again withdrawn, similar to the way a credit card works. Collateral is not required for loans of $25,000 or less, and a lenderdetermined collateral policy is used for loans greater than $25,000 up to a limit of $350,000. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 30

35 Patriot Express Loans Patriot Express Loans are another type of rapid-turnaround loan that are reserved for businesses that are majority owned/controlled by military-affiliated individuals. This includes veterans (excluding dishonorable discharges), Active Duty potential retirees (retiring within 24 months), and Active duty personnel within 12 months of their discharge date. National Guard members and reserve personnel are also eligible, as are spouses (current, or former in the event of service-related death) of military personnel. These loans have a turnaround of 36 hours and have similar collateral policies to Express Loans, the only difference being mandatory collateral on loans larger than $350,000. Loans revolve and have terms of 7 years or less, although extensions can be negotiated, and insure between 75 and 85%. Rates are capped at prime plus 2.25% or prime plus 2.75%, for terms less than or equal to 7 years and greater than 7 years, respectively. Small loans can incur higher rates (+1% for $50,000, +2% for $25,000 or less). The maximum principal is $500,000. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 31

36 Step-by-Step Plan for Getting an SBA or Bank Loan By now, you are probably wondering How can I go about getting a loan like this for my small business? Here is a step-by-step plan to guide your through the process of raising this form of capital to finance your venture. Step One: Invest Your Own Equity Banks like to see that you are personally invested in your business, financially and otherwise, so that you have a larger stake in its success. As discussed, with SBA loans, banks prefer when the owner has invested over 25% of the requested funds into the business. As mentioned, to get to this 25% mark, you might need to seek friends and family or angel financing before requesting an SBA loans. Or, you can finance the early stages of the business with credit cards, and re-invest the earnings (which is now your personal capital) into the business. Step Two: Assess Your Needs Where is your business right now, and where are you trying to take it? How are you going to get there, and what resources will you need to do it? These questions are critical for determining what kind of loan you need and for how much. They re also very important for writing your business plan, and for convincing the banks that you re going to be a good borrower. Set specific goals and make reasonable estimates of all the costs and expenses you will incur as you try to achieve them. This will give you an idea of how much you need to borrow. Step-by-Step Guide to Raising Capital from Banks & SBA Lenders Page 32