Exploring Guaranteed Loans as Startup Business Capital
In a recent blog post on financing businesses, I mentioned government guaranteed business loans as a potential source of startup capital. Guaranteed business loans are offered by the Small Business Administration (SBA) and United States Department of Agriculture (USDA). By guaranteeing all or part of a loan, the government reduces a financial institution’s risk and incents the lender to make a loan they would not normally make, including startup business loans.
Guaranteed loans are not easy to obtain.
They require extensive documentation, strong commitments by the borrower and may require the personal guarantees of the owners. Regardless, government guaranteed loans can be extremely helpful to business owners, serve a wide variety of business loan needs and can be very attractive for many borrowers.
Since the USDA Business & Industry Loan Guarantee Program is limited to rural areas, they aren’t discussed here, but there is a link at the bottom for more information on this program. The following information focuses on the more widely used SBA loan programs. Program details are extensive so a brief overview and a link for more information is offered below.
SBA Loans
The SBA offers a variety of loan programs that are distinguished by the uses of funds, loan amounts and lender requirements. The two most prevalent programs are 7(a) Loans and 504 Loans.
7(a) Loan Program
This is the SBA’s most popular loan program due to its flexibility and broad eligibility requirements.
Eligibility – Eligibility is limited to for-profit businesses that meet SBA size standards and show good character, credit, management and ability to repay the debt. Some businesses are not eligible.
Loan amounts – Available up to $5mm and are guaranteed up to 75% for loans over $150,000 and 85% for loans under that amount.
Purposes – Expansion, renovation, construction, purchase of land, building or capital goods, working capital, debt refinance, inventory purchases or start-up businesses.
Terms – Dependent on the borrower’s ability to repay but up to ten years for everything but real estate and up to twenty-five years for real estate.
Interest and Fees – Loans can be fixed or variable rate but most are variable with rates ranging from Prime + 2.25% to Prime + 4.75%, depending on the loan amount and loan term. Borrowers pay several percentage points in fees for the program and in some cases, pre-payment penalties may apply.
Benefits – Long-term financing, fixed maturities, no balloon feature, improved cash flow compared to traditional bank loans due to longer SBA terms.
Certified Development Company Loan Programs or 504 Loan Program
The focus of this program is economic development including economic expansion and job creation. These loans are made jointly by financial institutions and Certified Development Companies (CDCs). Unlike the 7(a) program, the bank’s portion of these loans is not guaranteed. Instead, the lender is incented to make the loan by having a low loan-to-value ratio and a first lien position on the collateral.
Eligibility – For-profit businesses with under $15mm in tangible net worth and with a two year average net income no greater than $5mm. Real estate must be 51% owner occupied or 60% for new construction.
Loan Amounts – Project costs are generally limited to $5mm or less and proceeds must be used to finance long-term fixed assets.
Loan Structure – A financial institution makes a loan for the first 50% of the project, the CDC makes a loan for up to 40% of the project cost and the borrower covers the difference which is usually 10%-15% of the project cost. Limiting the bank’s risk to 50% and giving them a priority lien position on the project ensures they can be repaid if the loan defaults and assets are liquidated. The CDC portion is secured by a second lien on the assets and is 100% backed by SBA debentures.
Purposes – The program provides financing to acquire, renovate or refinance capital assets including land, buildings and equipment.
Term and Rate – The program offers financing up to twenty years on real estate and heavy equipment. The CDC portion of the loan is usually a ten or twenty year term and is offered with an attractive fixed rate loan. The bank or financial institution’s loan term may be shorter than the CDC term and may be fixed or variable rate. By combining the bank’s market rate with a low fixed rate, financing costs on these loans can be very attractive.
Fees – Origination fee of .5% on the lender’s portion of the loan and up to 1.5% on the CDC portion of the loan. Monthly servicing fee of .625% to 1.5% is charged on the unpaid loan balance. An ongoing guaranty fee of .9375% is assessed on outstanding balance.
Benefits – Low down payment, long-term financing, fixed rates on a portion of the debt, full amortization (no balloon feature) and program costs and fees may be financed in the transaction.
Learn More About Guaranteed Loan Programs
For more information on SBA loans including the 7(a) and 504 Programs, see the SBA Small Business Resource Guide.
For more information on the USDA Business & Industry Guaranteed Loan Program, visit the USDA website.
Note: Information provided is current as of the date of publication, although it may change later. Consult with your banker for the most up-to-date information.
Andy Jordan is an expert in community banking with experience a as Senior Staff Auditor, Compliance/Security Officer, Branch Manager, Commercial Lender, and Community Executive / President. He is currently Senior Lending Officer at Providence Bank in Milton, Georgia.
