Is
An SBA Loan Your Best Answer?
Date 3-10-2005
If you own a small, growing business and you are in need of financing
real estate, equipment, or machinery, where do you turn? Perhaps you
go to your local bank. But what if your business lacks the type of
tangible, “hard assets” that banks favor as collateral. “Hard assets”
is a banking industry slang term meaning anything you can touch or see
that has value to a lender as collateral, like a building or a tractor
or a machine.
The reason banks like to lend against “hard” assets is easy for anyone
to understand. If things go wrong, like the borrower becomes unable to
repay the bank, it is easy for the bank to go to the borrower’s place
of business recover its collateral. Once the collateral is in the
possession of the bank, it may sell the collateral to recoup its loss
on the loan. Of course, there are some legal hoops they may have to
deal with like foreclosure or obtaining an order from local law
enforcement to enter your property to recover property, but in any
event, the collateral can be recovered and sold.
Banks do an admirable job of lending money to small businesses in need
of financing hard assets. Generally, these loans are term
loans—repayable to the bank in equal monthly installments of principal
and interest over two to five years. To encourage banks to make these
types of loans to small businesses, the U.S. Government provides
incentives like loan guaranties through the U.S. Small Business
Administration (“SBA”).
Essentially, the thinking goes like this: Investment by businesses in
machinery, equipment, trucks, tractors, and construction stimulates
the U.S. economy and generates employment. Since banks finance the
bulk of this type of investment for business, the U.S. government,
through the SBA, provides incentives for banks. The SBA tells banks
that if a borrower meets certain minimum standards—generally lower
standards than banks would otherwise require, the SBA will guaranty
the bank repayment of a large percentage of the loan—even if the
borrower defaults.
In other words, borrowers who may not otherwise qualify for a bank
loan in the absence of an SBA guaranty, may qualify for a loan if
guarantied by the SBA. Everyone wins. The government has done its job
to stimulate the economy, the bank earns interest on a loan it
otherwise may not have otherwise made, and the borrower gets to expand
its business.
Before you start thinking that an SBA loan is perfect for your small
business, let’s examine the loan requirements a little more
thoroughly. First, when banks act alone, they are free to underwrite
their loans in any way it make sense to them, provided they don’t run
afoul of the regulators. Generally, if a bank wants to lend a borrower
80% of the value of a new tractor, the bank will usually secure the
loan only with the vehicle’s title. No additional collateral is
necessary. But a bank that is relying on an SBA guaranty for
additional security has to play by SBA rules. The loan, while easier
to qualify for, may be much more restrictive when it comes to its
terms.
For example, the SBA may require the bank to obtain a “blanket lien”
on all the borrower’s assets, including even assets which are not even
remotely related to the loan request. A blanket lien is a “pledge” of
all assets to secure a loan. It may not be unusual therefore, for an
SBA guarantied equipment loan to be additionally secured by your
inventory, accounts receivable, vehicles, machinery, land and
buildings. Blanket liens often lead to situations where the bank is
“over-collateralized”.
While being over-collateralized my be great for the bank and the SBA,
it is bad for you and your business. The bank being
over-collateralized puts the bank in control of your business and
makes it quite difficult (and in some cases impossible) for you to
convert equity you have built up on your assets (or should we say, the
bank’s assets) into cash to further expand your business, make
payroll, purchase additional inventory, take on larger accounts…you
get the picture. Sometimes the only relief is to find the money
elsewhere to pay off the bank and obtain a release.
You can protect yourself against this scenario. First, realize that
everything is negotiable. Ask lots of questions. Don’t assume that
because you are borrowing money to buy a truck, that buried in the
loan documents, you are not also giving the bank a security interest
in your accounts…or your inventory. Ask up front what the collateral
requirements are going to be and don’t give the bank any more
collateral than is absolutely necessary.
The reason for being stingy with what assets you offer as collateral
may not be clearly evident to the novice business owner, but those who
have been through several business cycles understand all too well. By
giving a bank too much collateral, you lose the flexibility to sell
the underlying assets or refinance them elsewhere to generate
emergency cash. Typically, if you want to sell any assets that the
bank holds as collateral, you must take part or all of the sales
proceeds and pay down the bank with it. But don’t forget to get the
bank’s permission first, or you might be accused of conversion—a legal
term referring to improperly disposing of assets that are subject to a
lien.
Emergency cash isn’t only needed when times are bad. You may need
emergency cash to expand your business quickly to take advantage of an
immediate opportunity. When times are good, and if you are really,
really nice and you beg your banker, he or she may release a
particular piece of the bank’s collateral so that you may sell or
refinance it to generate cash. But have you ever asked a lender to
release its collateral when times are tough. You can forget about even
asking.
Let’s examine an entirely different twist. Perhaps you are a service
business like a
temporary staffing firm, a
nurse staffing firm, or an
IT Staffing firm. You don’t have any “hard” assets like a manufacturer
or trucking company might. Business is good and expanding. You need
expansion capital to hire more people or to finance accounts
receivable. You will find that most banks, despite what they may say
publicly, are not thrilled about lending money to companies that don’t
have lots of hard assets. Why? Remember early on when we talked about
the bank liking to lend against assets they can see and touch? Service
businesses usually have few of those types of assets. More typically,
service businesses’ largest asset is their accounts receivable.
Will banks lend against accounts receivable? Certainly, if you
qualify. Will they lend you anywhere near their value? No. How do you
know if you qualify? Wait for weeks or months while the banker pours
over reams of paperwork he or she required you to supply. Then wait
for the loan committee to meet. Chances are they will ask for more
collateral, more restrictive terms, a higher interest rate, or more
information. Your banker will come back to you with this information
and begin the process again until loan approval is granted or denied
by the loan committee.
So let’s examine the pitfalls we were discussing two paragraphs ago.
Let’s say business is pretty good, you go to your bank and qualify for
an SBA guarantied (or non-SBA guaranteed) line of credit secured by
your accounts receivable. Perhaps you have $100,000 of accounts
receivable and the bank feels generous by offering you a $50,000
revolving line of credit secured by a blanket lien on all your assets.
Six months later, business really starts to take off. Monthly sales
are increasing 10% per month and now you have $160,000 in accounts
receivable, but no cash. All your cash is tied up in the hands of your
customers and you are having a tough time making payroll. What’s more,
a large, new, profitable order just came in and you’re afraid to take
it, because it would mean having to hire another employee—and you
don’t know how you’re going to pay the employees you already have.
You jump in your car, go down to the bank and say, “How about an
increase in my line of credit to $100,000 to help me expand my
business?” When your banker stops laughing at you, you will then
realize what millions of service business owners already know and I
explained earlier. If accounts receivable are your business’ primary
asset, don’t expect your banker to be thrilled to borrow money against
them, much less to increase the amount already committed. Remember,
your banker cannot see or touch your accounts receivable—so likely, he
or she won’t want to lend you (much) against them.
Here’s where the real trouble begins. You have an asset worth $160,000
today, but you borrowed $50,000 against it six months ago. Now, if the
bank is unwilling to lend more against your accounts, your have to
make some decisions. If your lack of working capital is causing real
pain like being unable to expand further, you must consider factoring
your accounts receivable.
A good
factoring company will analyze your accounts in 24 hours or
less and determine whether or not you are eligible. If you are
eligible, the factor will make a lump sum advance to you against your
entire book of accounts receivable, segregating the amount necessary
to pay off the bank and obtain a release of the bank’s rights in the
collateral. It is not uncommon in these cases for the borrower to walk
away with 50%, 100% or even 200% more net cash availability under a
factoring scenario than a borrowing scenario.
To generate the most working capital, consider
factoring accounts
receivable rather than borrowing against them. Not only is factoring
fast, flexible, and more affordable than you’d expect, but as you
experience growth in your accounts receivable, there is no nasty
confrontation with a banker when you need additional funds. As your
eligible receivables grow, so does the amount of cash available to
your company. In factoring, there are no loan committees, regulators,
government bureaucrats or auditors determining your fate. Access to
cash is fast and premised only on the quality of your customer’s
credit—not yours.
By: 1st Commercial Credit,
Account Representative
1st Commercial
Credit, a
nationwide
receivable
factoring company headquartered in El Paso, Texas. Provides accounts
receivable financing in the US, Canada, and the UK; offers
export trade finance to clients in every major world
market and can convert receivable finance transactions in 17
currencies.
View Recent Transactions
US and Canada Tel 1 800 450 9653
United Kingdom Tel 0 800 404 9669
Start Factoring Today!
This Document has been
digitally date stamped and is monitored. Please do not copy without permission.
Other Articles:
Other related pages by
industry:
Factoring Temporary Staffing Companies
Factoring Medical Staffing Agencies
Factoring IT Staffing Firms
Factoring Trucking Companies
Asset Based Lending
1st Commercial Credit (SM) is a trademark of 1st Commercial Credit, LLC.
|
[
[
[