Since its founding in 1953, the U. S. Small Business Administration has helped thousands of small businesses thrive and grow. By guaranteeing up to 90% of loans to small businesses, the SBA has enabled banks to expand their commercial lending, helping to create jobs and boost the economy. There are two main programs offered by the SBA, the “7a” loan and the ”504” loan. While both of these programs can be beneficial, there are some pitfalls in the 7a loan programs that every prospective borrower should understand before taking the plunge.
Under the 7a loan program, the SBA issues a guarantee to a lender for repayment of up to 90% of the outstanding balance. Depending on the collateral, the loan can also be made for up to 90% of the purchase price, greatly reducing the down payment needed by the borrower. However, there are some serious downsides to consider:
First, SBA 7a loans are written as adjustable rate loans tied to the prime rate. There are no ceilings or floors, so over a 20 or 25 year term, there is a real possibility that rates and payments can shoot up significantly. Additionally, loan fees are often higher than for conventional loans, and typically range from 2% to 3%.
Most critically, all of the business assets will be tied up to secure the 7a loan, even one collateralized by real estate. Inventory, receivables, and equipment will all be pledged. I have often seen businesses with 7a loans that have been very successful, but find that they are stymied from further growth, because their assets are all pledged and they can’t get the financing they need to get to the next level.
A final caveat to consider is that a lender may offer you a 7a loan, not because it is best for you, but because it is good for him. An SBA 7a loan can provide a quick payoff for the lender, because the guaranteed portion of the loan can be sold to investors at a tidy profit. SBA guaranteed portions are sold individually or bundled into securities that are traded in an active market. Beware of moral hazard when seeking financing for your business, especially if your lender is working for a commission. Be sure to work with a lender who has your long-term interests at heart, and who values a continued relationship with you.
As a practical matter, I have found that an SBA 504 loan or a conventional bank loan are almost always better solutions for my business customers. Borrowing costs are usually lower, and there is greater flexibility to tailor the terms to meet the customer’s needs.
I will write another post soon about the SBA 504 loan program as well as the advantages and disadvantages of conventional bank financing. In the meantime, call me or contact me with any questions you have about commercial borrowing.