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Feb 1, 2007
It takes money to expand a business. Banks exist to lend money, and they offer a wide variety of ways to fund small business growth. They are also a small business owner's conduit to Small Business Administration funding. Following is a primer on how lenders generally structure loans, along with some common variations.
? Line of credit loans: The most useful type of loan for many small businesses is a line-of-credit loan. This is a short term loan that extends the cash available in your business's checking account to the upper limit of the loan contract. You pay interest on the actual amount advanced, from the time it is advanced until it is paid back. Line of credit loans are intended for purchases of inventory and payment of operating costs for working capital and business cycle needs. They are not intended for purchases of equipment or real estate.
? Installment loans: These kinds of bank loans are paid back in equal monthly installment payments that cover both principal and interest. Installment loans may be written to meet all types of business needs. You receive the full amount when the contract is signed, and interest is calculated from that date to the final day of the loan. If you repay an installment loan before its final date, there will be no penalty, and an appropriate adjustment of interest.
? Balloon loans: These loans require only the interest to be paid off during the life of the loan, with a final "balloon" payment of the principal, which is due on the last day. Balloon loans are often used in situations when a business has to wait until a specific date before receiving payment from a client for its product or services.
? Interim loans: Contractors who are building new buildings often use interim financing, but a retailer who is buying or building a new store location can also often obtain this type of funding. When the building is finished, or its acquisition is complete, the owner can take out a mortgage on the property that can be used to pay off the interim loan.
Loans can be secured by an asset, which is used as collateral, or unsecured.
? Unsecured loans: An unsecured loan has no collateral pledged as a secondary payment source if the borrower defaults on the loan. The lender provides a borrower with an unsecured loan when it considers the borrower to be a low risk. A good credit rating along with a sound business plan is essential for obtaining an unsecured loan.
? Secured loans: These require the borrower to present some kind of collateral in exchange for a loan that will generally have a lower interest rate than an unsecured loan. The collateral is usually related to the purpose of the loan. For instance, if the borrower is using the funding to buy a vehicle or equipment, such as point of sale hardware, the purchase itself can often serve as collateral.
? Secured by receivables: Some banks, generally known as factors, will secure loans using the borrower's receivables as collateral. Typically, the lending institution will loan up to 75 percent of the amount due.
? Secured by inventory: A retailer's products in stock can also be used to secure a loan. In that case, the loan is usually valued at up to 50 percent of the sale price of the inventory.
? Letter of credit: Importers and international traders often use a line of credit, issued by a bank, to guarantee payment to suppliers in other countries. The document substitutes the bank's credit for the retailer's or other borrower's up to a set amount for a specified period of time.
Last year, the Small Business Administration loaned more than $50 million a day to U.S. small businesses. These government sponsored loans are neither free nor interest free.
In general, all SBA programs are targeted at small companies (that is, businesses with less than $7 million in tangible net worth and less than $2.5 million in net income), but typically most banks won't lend to startup businesses that don't have two to three years' worth of financial statements and some owner's equity in the business. Some banks will allow you to use money from relatives as part of your equity, but you're required to formalize these loans with a repayment plan that's subordinate to the bank debt.
The SBA doesn't even actually lend funds directly to entrepreneurs and small businesses. Borrowers seeking SBA funding must work through a relationship with a loan officer at the local bank, credit union or nonprofit financial intermediary to access the programs. Once that relationship is established, however, there is an array of resources aimed at getting the capital needed to expand a small business. Among them are:
? 7(a) Loan Program: The 7(a) is the SBA's most popular loan program. The eligibility criteria for the 7(a) program are the broadest of all the SBA loan programs, but they're still quite restrictive for startups and businesses related to financial services. A small business owner can obtain up to $750,000 from a local 7(a) lender, backed by a partial guarantee from the SBA. Note that the SBA is not lending any money directly. The SBA is making it less risky for a local lender to provide the financing. A 7(a) loan is typically used for working capital, asset purchases and leasehold improvements. All the owners of a business who hold an ownership stake of 20 percent or more are required to personally guarantee the loan. There are variations within the 7(a) loan program.
? The Lowdoc Program: This is typically used for an SBA borrower looking for less than $150,000 under the 7(a) program. It was created in 1993 to reduce burdensome paper work. A Lowdoc loan application is a one page form with the borrower's application on one side and the lender's request to the SBA for the guaranty for the loan on the other. The SBA responds to Lowdoc applications within 36 hours.
? SBA Express: This is a program for lenders with a good SBA lending track record. It's aimed at getting money (in this case, as much as $250,000) quickly into the hands of small business owners.
? Community Express: This was based on the success of the SBA Express program, and is specifically designed to improve access to capital for small business borrowers with low and moderate incomes. Technical assistance, provided to the borrower both before and after the loan, is a component of this program.
? 504 Loan Program: This program is intended to supply funds for asset purchases. Typically, the acquisition is funded by a loan from a bank or other local lending institution, along with a second loan from a certified development company (CDC) that's funded with an SBA guarantee for up to 40 percent of the value of the asset (which is generally a loan of up to $1 million ) and a contribution of 10 percent from the equity of the borrower. This financing structure helps the primary lender, the bank, reduce its exposure by relying on the CDC and the SBA to shoulder much of the risk. Like the 7(a) program, the 504 program is restricted to small businesses with less than $7 million in tangible net worth and less than $2.5 million in net income. Personal guarantees are also required for 504 loans.
? 7(m) Microloan Program: The program is intended to provide small loans of up to $35,000 that can be used for a broad range of purposes to start and grow a business. Unlike the 7(a) program, the funds to be loaned don't come from banks, but directly from the SBA and are administered to business owners via nonprofit community based intermediaries. The Microloan program is friendlier to startups than established businesses because a pre condition of the Microloan program is that borrowers typically have to enroll in technical assistance classes administered by the lender intermediaries.Information in this article was edited from a story on Entrepreneur.com, sponsored by Entrepreneur magazine.
Topic: Business Strategies
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