Ask 10 small business owners to tell you the most frustrating aspect of running their business, and eight of them probably will name the area of financing. Obtaining adequate funding to meet day-to-day working capital, inventory and facilities needs is a major challenge.
Of course, the first place to start when in need of a small business loan is your bank. Most businesses don’t need a tremendous amount of outside financing to start or sustain the venture. In fact, many are started with less than $25,000 in working capital. However, many conventional bank loans aren’t well-suited for micro loans (under $25,000), or to finance new businesses.
If you have already tried your bank with little success, don’t despair. There are a number of special loan programs out there that are well-suited for “small” small businesses. Some are designed for loans of up to $100,000 or more, while others can address the micro loan needs that often arise in a small business.
Let’s start with three programs offered through the U.S. Small Business Loan Administration and then look at an example of a local program in Winston-Salem, N.C., that is indicative of many micro loan programs available around the country.
SBA Low Documentation Loan Program
The Small Business Association (SBA) has been offering guaranteed loans to U.S. small businesses since 1953. The 7(a) guaranteed loan program has been offered for many years. with annual volume averaging in the $10-million range ($10.146 million in 1999) in recent years. However, it wasn’t until July 1994 that the SBA offered its Low Documentation loan program (initially for small business loan requests of under $100,000, now up to $150,000) to the masses after successfully piloting the program. Since that time, the government agency has seen an unprecedented success story unfold.
“Before we began to offer the Low Doc program, it just wasn’t cost-efficient for lenders to go through the paperwork for a loan of under $150,000,” says Mike Stamler, spokesman for SBA. “The Low Doc program has made it easier than ever before to get smaller loans. This program has proven to be extremely popular both with small businesses and banks.”
Stamler’s point is well-supported by the numbers. In 1999, the SBA guaranteed 11,413 Low Doc loans totaling $852 million. This represented over 25% of the total SBA 7(a) guaranteed loan volume for those 12 months.
How does the Low Doc program work? As with other guaranteed loans, the borrower works with his or her bank in formulating the loan request, with the bank actually submitting the request to the SBA. The SBA provides the bank with a guarantee for up to 80% of the loan amount if under $100,000, and up to 75% for loans in excess of $100,000.
The stated objective of the Low Doc program is to put the emphasis on the borrower’s character, credit history. and projected cash flow, with less significance placed on percentage of equity and collateral.
“We see some real advantages in the Low Doc program,” explains Dick Rosentiel, director of Small Business Lending for Today’s Bank in Rockford, Ill. “The SBA’s underwriting parameters for this program involve the same characteristics that we look for in small business tier one loans. And the SBA has emphasized simplicity and rapid turnaround on loan requests, two things that have been greatly lacking in the past with the SBA.”
The simplicity of the Low Doc program has been the key to its success. The documentation requirements are far more manageable than those imposed for a standard SBA guaranteed loan request, which typically involves the completion of 10 or more forms and/or narrative summaries from the borrower. But for a Low Doc loan, the SBA requires only a completed one-page application form, along with some historical financial information on the business and the owner. And here’s one of the best parts. The SBA promises 36-hour turnaround time once a completed Low Doc loan package is received from the bank.
Start-ups are eligible for Low Doc loans, as are existing small businesses. For an existing business to be eligible, it must employ fewer than 100 employees and have average annual sales for the preceding three years of less than $5 million. As with the standard guaranteed loan program, proceeds may be used to finance working capital (up to seven years for the repayment term), machinery and equipment (up to 10 years) and real estate (up to 25 years).
The interest rate is negotiated between the borrower and the bank, but may not exceed Wall Street prime rate plus 2 1/4% for loans that carry a term of less than seven years, and prime plus 2 3/4% for loans of seven or more years. A 2% guaranty fee is also collected by the SBA when the guaranteed portion is $80,000 or less; a 3% guaranty fee is collected when the guaranteed portion is over $80,000.
SBA Women’s Prequalified Loan Program
Another relatively new loan program for the SBA is the Women’s Prequalification Loan Program. Stamler says the reason this program was started is simple. “The SBA seeks to improve on the number of loans to women-owned businesses,” he explains.
According to SBA literature, this program “allows a woman-owned business owner to receive prequalification from the U.S. Small Business Administration (SBA) for a loan guaranty before going to a bank.” The key word here is “before.”
The Women’s Loan Program is the only SBA-guaranteed loan initiative that allows the borrower to go directly to the SBA for approval. The bank becomes involved only after the SBA has signed off. Obviously, this is a big advantage because a bank is more likely to consider a request for a new or young business that has already been approved with an SBA guaranty.
As with the Low Doc program, the Women’s Loan Program focuses primarily on the credit history, character and experience of the borrower.
Consequently, there are no stated minimum equity or collateral requirements. The maximum loan amount in the Women’s Loan Program is $250,000. The SBA will provide the bank with a guaranty of up to 80% on loans up to $100,000 and up to 75% on loans between $100,000 and $250,000. In order to be eligible, a small business must be at least 51% owned, operated and managed by women, have annual sales not exceeding $5 million, and employ fewer than 100 people.
For loans under $100,000, the SBA requires only that the borrower submit a one-page application. For loans of $100,000-$250,000, the borrower must submit an expanded application, resumes on the principals, a copy of the most recent year-end business financial statement or tax return. and a personal statement. The restrictions for maximum interest rates, fees, terms and uses of loan proceeds are the same in the Women’s Loan program as for the standard guaranteed loan program and for the Low Doc program.
How can you tap into this source of financing for your small business? Contact your local SBA office, and they can get you started on an application.
SBA Micro Loan Program
The SBA Micro Loan Program was started in 1992. Funds are made available to non-profit intermediaries, who in turn extend financing to local small businesses. Loan amounts range from $100 to $25,000, with an average loan size of $10,000.
The maximum term allowed for a Micro Loan is six years, and the term may be less depending upon the size of the loan, the planned use of the funds, and the requirements of the intermediary lender. Interest rates generally are competitive and are set by the intermediary lender. As for collateral, any assets being purchased with the loan proceeds will be required to be pledged. And the small business owner will be expected to provide a personal guaranty.
The SBA provided 1,466 Micro Loans totaling $17 million in 1999. Stamler says the program has helped meet a niche for truly small businesses unable to obtain credit from conventional sources.
“These sorts of loans are more appropriate for people who generally are not considered bankable,” Stamler says. “It’s usually not a question of the size of the loan being too small for a bank to deal with, but the borrower himself or herself. In the absence of the program, most of those borrowers would not be getting loans from banks, anyway.”
To find out the closest Micro Loan intermediary, or for more information on the above SBA-related special loan programs, check out the website www.sba.gov or call the SBA Answer Desk at 800-827-5722 between the hours of 9 a.m. and 5 p.m. Eastern Standard Time.
Other Micro Loan Programs
The SBA is not the only entity that offers micro small business loans. Many local and state governments also have similar loan programs. In fact, many are not well-known, but are ideal for the small business owner who needs up to $25,000 to start or sustain the venture. One such program is the Micro Enterprise Loan Program of Winston-Salem, Forsyth County, Inc., in North Carolina Nicknamed MELP, this loan program was initiated four years ago by a consortium of eight banks, two large corporations, a local foundation, and the city and county governments. According to Mark Harden, a founding Board member, MELP initially targeted small loans of $5,000 or less for minority- and women-owned businesses. Within a year, however, the program was expanded to include all small business owners with the loan amount increased to $20,000.
“The program is for fledgling businesses,” explains Harden, a credit risk manager with Centura Bank in Winston-Salem. “The businesses are very small, and some are even start-ups.”
Harden adds that the typical MELP loan has been about $7,500, with a two- to three-year payback. And he sees it as a great fit for just about any small business. “Many of our loans have been to micro businesses with five employees or less,” Harden says. “This is an excellent program for truly small businesses.”
Harden points out that there are micro loan programs such as MELP all over the country. Some, like MELP, even offer grants. To find out more about local micro loan programs, Harden suggests that you contact your local municipality. Even if there is no program designated for your area, the local officials may be able to connect you with state programs.
Regardless of the type of special loan program, it is important to be prepared when you go to apply.
Prior to formally applying for the loan, you should complete the following to expedite the process:
- a narrative business plan;
- profit-and-loss projections for three years;
- resumes on key managers and owners;
- outline of how the loan will be used, including a listing of assets to be purchased;
- at least three years of historical financial statements on the company;
- personal financial statements and tax returns on all owners;
- proposed collateral structure.
The business plan may require only four to five pages to summarize these areas, but the important thing is that the small business owner demonstrate that the idea and potential pitfalls have been thoroughly considered.
Some of the sections that should be included are:
- products and services;
- milestones you plan to reach;
- funds required to run the business.
Your local library should contain a number of good books to help you with the preparation of the business plan.
For SBA-related loans, there are also a few basic financial requirements. For existing operations, the SBA generally looks for a debt-worth ratio (total liabilities/total assets) of no more than 3:1 subsequent to the loan being made. A start up must have at least 30% in equity invested by the owners.
In addition to the capital requirements, the SBA looks very closely at cash flow (both historical and projected), and the background and competence of management.
If you are in need of even a small amount of outside financing for a business venture, programs like these may provide options for your business working capital needs. There is hope in site if you know where to look, regardless of whether you need $1,000 or $100,000 or more to make your small business more successful.