This Franchise Chatter Guide on SBA small business loans was written by Brian Bixler.
According to most major economic indicators, such as unemployment numbers and stock market activity, the U.S. economy is bouncing back from the Great Recession. That bodes well for potential franchisees who might be seeking a loan to open their business and there is perhaps no better economic indicator for them to consider than the approval of Small Business Administration loans.
“Certainly during the recession/mortgage crisis, lending halted to a slow crawl,” says John Bang, founder of Prime Resource Capital, which connects borrowers with commercial lenders. “Fast forward to 2014, SBA 7(a) lending has almost doubled from trough to peak. The facts speak for themselves, according to the SBA, in 2009 there were $9.2 billion in SBA 7(a) loans. This year, 2014, there were $19.2 billion in 7(a) loans closed.”
Standard SBA 7(a) loans are the most popular loans guaranteed by the federal government for up to 85 percent of loans of $150,000 or less and 75 percent for loans over that amount. Approval depends on many variables, including the borrower’s credit, terms, collateral and the type of loan; but typical loan rates are the Prime lending rate, plus 2.75 percent to 5 percent.
SBA Loan Uses
The 7(a) program is designed to provide small businesses with financial assistance to cover the vast majority of business expenses, such as short and long-term working capital, exports, and, under certain conditions, refinancing existing debt.
Typically, a borrower who is opening a franchise can finance equipment, franchise fees, working capital, property, machinery, auto and accounts receivables. In fact, franchisees may have an advantage over entrepreneurs opening a new start-up company because they can provide a proven business plan and model in the documentation necessary when applying for the loan.
Bang’s company, Prime Resource Capital, acts as a matchmaker, linking qualified borrowers to the right lender. He works with all kinds of entrepreneurs, including franchisees, to match borrowers and lenders, according to the borrower’s needs.
“Our expertise is in helping businesses find appropriate sources of capital based on the individual needs of the borrower,” Bang said. “We also offer assistance in business plan writing, financial modeling and consulting for those in need of those services. For lenders, we identify companies that are seeking funding and match the lender to the borrower based on the type of financing best matched for both parties.”
In franchising deals, typically a borrower will need at least 20 percent in capital injection, sometimes less, depending on their situation. And from the very beginning of the process for becoming a franchise partner, the borrower should be exploring financing options, he said.
“Under-capitalization is one of the key traits that breaks a business. At the very beginning of your search for a business—franchising or going it alone—financing your operation is a key aspect that one must grasp in order to succeed. Potential borrowers should analyze the cost versus benefit of using leverage to operate/start their venture.”
The SBA 7(a) is just one loan option available to borrows, including a handful of others from the SBA. There is also peer-to-peer financing available and other loan vehicles from conventional banks. If borrowers are not familiar with the terrain, they should seek advice from a loan professional like himself, Bang said.
“Each individual will have different issues or circumstances that will contribute to or hinder their ability to obtain a loan. If a borrower has existing relations with a bank and has experience with drafting a proper loan package, the services of a commercial loan consultant (broker) may not be needed.”
“However, if this is your first venture or if you would like the assistance of a person that deals with these types of loans on a daily basis, it could be very advantageous for a borrower to work with a commercial loan consultant.”
Why Go to a Commercial Loan Consultant?
Bang lists some of the advantages of working with a commercial loan consultant:
- It may save the borrower money on some fees that could be negotiated with the lender. Certain fees could be negotiated depending on the particular characteristics of the loan and the lender.
- Commercial loan consultants have access to lenders that borrowers may not know about. Also some lending institutions will only work with commercial loan consultants, knowing that deals were pre-underwritten and screened. That saves time and decreases marketing efforts for the lender.
- Depending on the deal, commercial loan consultants will know which bank will most likely approve it even before the application is submitted. This can help in expediting the process and saves the borrower from going to a dozen different banks to get a deal approved.
- Using a commercial loan consultant can reduce the number of times a borrower’s credit is checked. Through a consultant, credit may generally be pulled once, maybe twice during the whole loan process. The consultant will pull the borrower’s credit at the beginning of the process and then once again when the lender has issued a letter of intent and it’s ready for a final underwriting review. “Alternatively, if a borrower is going to multiple banks, they generally will be getting multiple ‘pulls’ on their credit history, thereby risking a decrease in their overall credit score,” Bang said.
The fees for using a consultant will vary according to the difficulty of the loan, the type of loan and the loan amount, Bang says. Consultants fees can range from 0 to several points, depending on the same factors. If consultants fees are zero, the consultant would be receiving compensation from the lending institution.
“Sometimes situations will dictate a due diligence fee, especially if the loan situation is very complicated,” says Bang. Those fees might start at $250. Banks and other lending institutions might also charge an application fee to weed out time wasters and also to cover costs in labor associated with reviewing loan packages.
A Solid Business Plan
Whether the borrower uses a commercial loan consultant or not, one of the first things they will need is a solid business plan. Because most franchises already have a proven system, a potential franchisee usually has an advantage here.
One of the most useful documents will be the company’s Franchise Disclosure Document, from which the applicant can pull start-up costs and other data to formulate projections. Item 19 on the FDD may disclose earnings which can be used as a guide. Any adjustment from the figures provided by the franchisor should be noted with explanations.
“Write a concise, plain English business plan that clearly states how much capital you need, how you will spend that capital and how you will pay back that capital,” Bang says. “Write as if the reader has never heard about the business/concept. Make sure your projections are realistic and back up your reasoning.”
The FDD and a business plan with an executive summary are just a few of the documents a borrower needs to compile into a loan application package, Bang said. Others include:
- Personal financial statement
- Three years of 1040 tax returns
- Three years of 1120, 1065 and Schedule C forms
- Interim financials (balance sheet, income statement)
- Credit report
- Projections for the next 2-3 years
Other documents may be needed based on the individual situation, he said.
First and foremost, a good loan application needs to show cash flow. “According to SBA lending standards, if the business lacks reasonable assurance of repayment from the cash flow of the business, the loan must be declined, regardless of collateral available or outside sources of cash.”
The length of time to acquire an SBA loan can typically be 45 to 60 days. But other types of loans can be quicker.
“Assuming all documents are in place, some loans can take as little as seven days and as long as 90 days,” Bang said. “But typically the length of time it takes to close a loan depends on factors such as, but not limited to: missing documentation, appraisals, underwriting, SBA approvals, asset valuations and credit mediation.”
A borrower’s credit history is a major variable in determining whether or not he or she gets a loan. Some loan programs exist that will allow for lower credit scores but they may require additional collateral. Typically, credit scores will determine initial eligibility. To improve his or her chances of the loan being approved, a borrower with bad credit might be wise to apply with a co-signer who has good credit.
“Most business loans, including SBA loans, are recourse loans where the borrower is personally guaranteeing the loan,” Bang said. “Starting a business is a risky proposition; one must be well positioned and prepared to take on such a risk. Of course, with risk comes reward, so plan well and use professionals for sound advice.”
There are also special loans that offer discounts for some applicants, and a commercial loan consultant will likely have good knowledge about the products and the terms that must be met for those types of loans.
“Lenders and the SBA typically will offer incentives for veterans, but consulting a loan professional is best, since those incentives often change,” he said.
One alternative to an SBA loan is a financing option offered directly from the franchisor. Franchising plans from franchisors began to pop up in the wake of the recession when money from traditional lenders was tight.
Typically, however, most franchisors offer just the FDD, which can be put to good use in applying for a variety of loans.
“In Item 19 of the FDD, the franchisor may or may not disclose some earnings information that may be useful in the forecasting and business planning stages, but typically a franchisee will want to speak to existing franchisees for more information,” Bang said.
“The franchisor may also offer assistance in writing the business plan, perhaps in the form of a template or business plan review. Additionally, the FDD will spell out the approximate start-up costs and ongoing costs that the borrower will need for his or her business plan.”
Streamlining the Process
The SBA has a list of approved franchisors that also helps streamline the loan process for would-be franchisees. The advantage stems from the fact that they are investing in established processes, systems, technology, training, marketing and operational support the franchisor provides as part of the investment.
But while the SBA has a variety of lending products for entrepreneurs, it is not the be-all and end-all of financing options. For example, nonprofits, financial businesses involved in lending, life insurance companies, government-owned entities and many other types of businesses are considered ineligible for SBA loans. Again, a commercial loan consultant can help determine the eligibility of an individual business or franchise.
Special considerations might also apply to some types of individuals and businesses. For example, franchises are eligible except when a franchisor retains power to control operations to such an extent as to equate to an employment contract; the franchisee must have the right to profit from efforts commensurate with ownership, Bang said.
According to The Hartford’s 2014 Small Business Success Study, 36 percent of the small business owners surveyed used personal sources of funding, such as personal savings, retirement savings or capital from their family and friends, over traditional sources of funding.
However, in a recent report on Forbes.com, bank loans were still considered the best source of financing.
“Banks simply have the cheapest money to loan because of their access to checking and savings deposits,” the report states. “This also gives them a pretty great incentive to court business owners, who make a lot of those deposits.”
The downside to banks and credit unions is the high bar to qualify.
Commercial alternative lenders such as merchant advance loans or peer-to-peer lending sites can also give small business owners quick access to capital, but the terms can be more expensive than other alternatives, the report advises.
That’s why SBA loans are so viable, Bang said, especially for franchises.
“When a bank approves a loan and the loan is sent to the SBA office for final approval, the SBA office does not need to review the franchisor’s business if the franchise is already on the approved list.”
For more information about John Bang and his company Prime Resource Capital, go to the website www.primeresourcecapital.com or email John at firstname.lastname@example.org.