Business writer Jennifer Hickey recently spoke with Charles H. Green, who spent 30 years in the commercial banking industry and is now the executive director of the Small Business Finance Institute, an Atlanta, Georgia-based nonprofit that helps business owners improve financial management and access to funding through annual conferences, monthly workshops, and a weekly webinar series on various topics. He is also the author of the SBA Loan Book, now in its third edition.
JH: What role does a bank or lending institution play in administering SBA loans?
CG: The Small Business Administration (SBA) does not make the loan directly but serves as a guarantor for the loan up to a certain percentage depending on the program. The intention of the program is for lenders to make loans under their existing lending criteria or policy. If a loan can be approved without the guaranty, it should be. If it cannot be approved due to being outside loan policy and is a prudent loan likely to be repaid, the lender can proceed with the guaranty. The guaranty is intended to shore up a loan for borrowers who would not otherwise be able to get a small business loan, as their collateral levels, requested leverage, credit score, or repayment terms, etc. fall outside that criteria.
CG: Traditionally, bank regulators have discouraged financing beyond the horizon of which would be a safe risk. SBA-backed loans allow for longer term financing that banks would be discouraged from giving based on existing lending criteria. For example, an SBA loan allows a company that wants to purchase a building for manufacturing or retail purposes to finance the loan for up to 25 years. Bank regulation sees that as a long time to take a risk and commit money without knowing what the cost of funds will be, how well the business will do over time, etc. Yet, it’s impractical to think an asset that will be useful over 20 years can be repaid in three years. The SBA guarantee encourages the bank to make loans that would otherwise not be possible due to the regulatory environment.
JH: What types of provisions must be met for the most common types of SBA loan programs?
CG: The most commonly used is the 7(a) program, which provides a 75 percent guarantee for loans up to $5 million and up to 85 percent for loans under $175,000 until the loan has been paid in full. A loan backed by the 7(a) loan program can be used for any business purpose and the maturity is based on the use of proceeds. The loan can have a maximum term of up to 25 years if used for property and up to 10 years for equipment financing and seven years for working capital.
The second most used program is the Certified Development Company (CDC)/504 loan program, which provides subordinate financing directly to the small business and is administered locally through SBA-licensed nonprofit CDCs. A 504 loan can only be used for capital improvements, like the acquisition or construction of capital assets such as property or major equipment. It is not a guarantee like the 7(a) program but a funding augmentation. The SBA actually participates in the funding of this program by selling debentures, which serve as a subordinate piece of the total financing (up to 40 percent), while the CDC funds a minimum of 50 percent of the transaction.
The SBA Express program allows for the funding of much smaller initiatives, up to $350,000 ($500,000 for qualified veterans) and carries a smaller guarantee by the SBA, generally 50 percent (75 to 80 percent for veterans). While the program target is working capital, it can be used for any business purpose. Express loans are fast-tracked; there are fewer forms required from lenders to the SBA, and lender is allowed to use their own loan documents to close the deal.
JH: What’s the difference between a preferred, standard, and certified SBA lender?
CG: This refers to the status or recognition of the lender by the SBA. A “standard” lender is one that is qualified to make an SBA loan, having entered into an agreement with the agency that allows it to submit transactions for review and receive a guarantee on the credit if approved by the SBA. Once the lender gets some experience and demonstrates its ability to follow the rules and generate decent volume, it can become “certified,” which puts its deals in the front of the line. With “preferred” status, the SBA actually allows the lender to make the decision whether to use the guarantee or not, and in many cases, the loan can be approved the same day. With standard and certified lenders, the SBA checks for eligibility and also reviews the lender’s application to ensure the loan is underwritten with a high degree of certainty that it meets SBA credit standards. With a preferred lender provider (PLP), the SBA only checks the lender’s justification of eligibility for the borrower, not their underwriting.
JH: Explain some of the different eligibility requirements for obtaining an SBA loan?
CG: A small business has to be “active,” meaning that it is directly involved in economic activity. Businesses involved in passive investments, third-party financing, or speculative business activity would not be eligible. And the loan must be used for legal business purposes, of which there are restrictions; it cannot be used be used for gambling-related activities, lending, multilevel marketing, real estate investment, charities, among others.
A borrower has to fall under the SBA’s definition of a small business, as described under the North American Industry Classification System (NAICS), which places a limit on specific industries based on number of employees and revenue levels. In general, businesses with fewer than 500 employees, or less than $7.5 million of annual revenue, are considered small businesses, though there are hundreds of differences within those generalizations, depending on the industry. Some have more or fewer employees, while others have a lower or higher revenue ceiling. For example, a car dealership can have up to $33 million in revenue and still be eligible for an SBA loan. It depends on the relative numbers in that particular industry.
The borrower must be a legal U.S. resident (i.e. a citizen or approved status) and has to be current on his/her income taxes and/or child support. In the SBA Business Loan Application, applicants must acknowledge and confirm they are in compliance with several statutes ranging from the Lead Based Paint Poisoning Prevention Act to the Right to Financial Privacy Act. The “other resources” rule states that if a borrower has a certain level of resources available to them, they would not be eligible for SBA financing. So, if a business has more than $2 million in cash, it would not be eligible for an SBA loan since it would qualify for financing elsewhere.
JH: Is there any additional documentation or collateral required for an SBA loan vs. a traditional business loan?
CG: The “paperwork” reputation of the SBA is overblown and concerns lenders not borrowers. The credit decision to make the loan is ultimately made by the bank, although the SBA can decline guarantee for a standard program lender if the borrower really wasn’t eligible or didn’t demonstrate the ability to repay the loan adequately. A loan may be rejected if, in the view of the agency, the projected financial results can’t be justified by either past performance of the business or with the accompanying business plan that sets forth how the financial objectives will be achieved.
The SBA loan program stipulates that if borrower collateral is available, it must be put toward the loan. For example, if the borrower is using loan proceeds to buy a building for its business, then that building would be put up as collateral for the loan. But there’s no firm rule on how much collateral is adequate. The SBA expects the bank to apply the same requirements as they would for any other type of business loan; however, there’s more flexibility with an SBA loan when it comes to collateral, credit scores, etc., if the financial projections are sound and based on real numbers.