As part of the 2009 American Recovery and Reinvestment Act (ARRA), the U.S. Small Business Administration has launched a $730M recovery program that includes a new $255M loan guarantee program guaranteeing up to 100% of loans made to small businesses (http://www.sba.gov/recovery/REC_LEARN_PROGRAMS.html). If you are interested in applying for one of these programs, there are a number of basic things one should consider:
- You must be a viable small business – viable as defined by SBA is a business that has been in operation 3 years with at least 1 profitable year in that time period
- You have to meet the standards of local loan providers mainly banks which can be summarized by the 5 C’s of Credit (see below)
- For some of the programs, you must have an existing non-SBA loan from a financial institution
- In some cases, you must be in distress (aren’t we all somewhat distressed?)
In the last couple of years, we have worked with a couple of companies who have successfully secured significant SBA loans both of which were early stage technology companies. Common characteristics of both were as follows:
- Both were post-revenue with revenues in the $100K - $750K range
- Both had to secure additional collateral for the loans – in both cases, an “angel” investor established CD’s that were used to secure the loans (at ~ 100% of the loan value). For this, the securing party retained the interest on the CD and obtained additional upside returns in the form of equity (warrants with a $.01 strike price).
- Both companies secured ~ $500K of loans
The major takeaway here is that you will likely need to find a backer to support your efforts. Unless you have an existing relationship with someone who could fill this role, you will need to treat this much like you would an angel investing opportunity. One of the significant benefits of using this approach is a reduced cost of capital. In addition to this, an external validation is achieved by a company that is able to obtain this type of financing. Last but not least, it is a great way to establish a relationship with a bank in your region who can back you for the long run.
The 5 C’s of Credit
Debt funding can be a challenge to entrepreneurial startups. There are several hurdles to clear; hurdles that are typical of small companies. You must understand that banks and other loan organizations are inherently risk averse. That is why they require collateral and personal guarantees. SBA loans are no different. They are typically administered through local debt providers who will apply their own application and loan approval process.
Regardless of the latest hype about SBA loans, debt funding still requires a ticket to the dance in the form of cash flow and collateral. If you are a small (risky) business, you will be expected to sign a personal guarantee.
Now having said that, here is an outline that describes the way debt providers evaluate a loan application. They commonly talk about the 5 “C’s” of credit.
Capital – Simply, how much money have you invested in the business?
Collateral – Many small business loans require a personal guarantee which commits you personally to be responsible for the loan in case the business cannot repay.
Conditions – What are you going to use the money for? Be as specific as possible; working capital, inventory, marketing costs, equipment purchase, etc.
Capacity – How will you repay the loan?
Character – Things like educational background business experience and references (business and personal) are used to determine character. Your tax history is important as well as your credit history.
We would add a 6th C; Credibility. While it is closely related to character, it goes to your business plan and how well you have thought through the things that could impact your business.