Bottom Line Business Insights : Maryland Business Lawyer & Attorney : Wagonheim Law Firm : Mergers & Acquisitions & Contractual Negotiation

A Business Plan is a living, breathing document that is assembled by a skillful business owner or manager with input from all sectors of his or her business. Correctly assembled, the Plan serves as a yardstick of progress in the short, medium, and long term. 

The most effective strategic business plans drill down from Vision to Mission to Goals to Tasks to Deadlines. For internal planning purposes, the Plan should project out no more than 18 months, should be examined every six months, and should be rewritten annually.

The best plans are often developed during a specifically scheduled and planned Strategic Planning Session. Depending upon the nature of the company’s management team, an independent and experienced facilitator can be invaluable in developing an effective strategic business plan that pays for itself many times over.

Despite many thoughts to the contrary, it is the small business (i.e. those with fewer than 500 employees) that can reap the most rewards from effective strategic planning. Unfortunately, too many business owners feel that strategic planning is either too expensive or a necessity only for larger enterprises. Nothing could be farther from the truth.

Bottom Line: Whether hand written at the kitchen table or developed using word processing and rich media, a Strategic Business Plan can be a business owner’s most valuable tool. What’s more, it works in the real world, not just in business school theory.

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Last week, in response to popular demand, I discussed one of the two major types of SBA loan: the Section 7(a) Loan (if you missed it, click here. This week, I wanted to finish the discussion of SBA programs by talking about the other popular SBA loan program, the Section 504 Loan. 

The Section 504 Loan is limited to very specific corporate purposes. The loan funds can only be used to acquire major fixed assets for expansion and modernization, such as purchasing land and improvements, construction of new facilities or modernizing obsolete facilities, or purchasing long term machinery or equipment. For these reasons, the 504 Loan is less likely to be the right loan for a startup company.

 A 504 Loan is really two separate loans involving two lenders, but it’s treated as a single transaction and both loans are closed at the same time. One of the lenders is a bank, which takes the 1^st lien position and lends up to 50% of the loan amount. The other lender is a Certified Development Company (or CDC for short), which is usually a nonprofit or local governmental economic development entity. The CDC takes the 2^nd lien position and lends up to 40% of the loan amount. Each lender’s loan will be secured by the assets being acquired.  The SBA’s role, as in the 7(a) Loan, is to act as a guarantor. Here, the SBA guarantees 100% of the 2^nd lienholder’s loan, but doesn’t provide any guarantee to the bank (the 1^st lienholder). The theory behind this guarantee structure is that the bank has greater security for its portion of the loan via its 1^st lien position on the assets being acquired and therefore doesn’t need the SBA’s guarantee. 

Additionally, the principal owners of the business are required to provide personal guarantees to both lenders (are you willing to pledge your house, car, savings, etc. for your business loan?). And since the 504 loan only covers 90% of the financing (50% loaned by the bank and 40% loaned by the CDC), the company must contribute 10% of its own money in order to be eligible for the loan. Thus, the increased likelihood that the 504 Loan is not going to be the right loan for a startup.

So, again, we come full circle to the difficulty of obtaining bank financing and the “theoretical” nature of SBA loans. The 7(a) loan can be difficult enough to qualify for, but in the case of the 504 loan, the company actually has to come up with 10% of its own money, provide personal guarantees, and provide liens on its equipment and real estate to the lenders.  Plus satisfy the underwriting standards of the bank and the CDC.

Now that I’ve touched on the main SBA loan programs, I think it’s important to point out that no bank is required to make an SBA loan. Banks are still free to reject any SBA loan application based on their own lending and underwriting standards, even though the loan would be partially guaranteed by the SBA. In addition to all this, there are also eligibility factors that businesses must meet in order to qualify for any SBA financing. I’ve represented many regional and national banks in lending transactions, so I’ve usually got a pretty good idea which lenders are most likely to make SBA loans. It’s probably worth a discussion if you’re interested in exploring SBA financing.  

Let me add here that I am not trying to discourage any business from applying for an SBA loan. I’m merely trying to illustrate what’s involved in the process, provide some details as to how these loans are structured, and perhaps stimulate some thought by business owners and clients. I think the SBA program can be a wonderful tool where a business can meet the lender’s and the SBA’s credit and eligibility criteria.  I encourage my clients to apply for SBA financing if they meet those criteria, and I am more than happy to help present my clients’ applications in the best possible light.

Finally, let me briefly mention a couple of other SBA initiatives that are geared towards small business: the SBIC program, which is a venture capital program sponsored by the SBA, and the SBG program, which is a surety bond program geared towards construction and contracting firms (SBG stands for Surety Bond Guarantee).

A few words about the SBG program: under this program, the SBA will guarantee a certain percentage of a surety bond where the contractor cannot get the bond issued through ordinary channels (and frequently, new or startup contracting businesses will have trouble obtaining surety bonds). This gives sureties an incentive to issue surety bonds in situations where they might not otherwise have done so. Which in turn gives startup construction businesses greater access to contracting opportunities. Theoretically, of course.

Next week, I’m going to discuss one more possible (and sometimes overlooked) way to finance your startup or business, which will conclude what I have to say about the legal aspects related to financing your company.

Questions? Comments? Concerns? Raise it for discussion on Facebook, Twitter, or LinkedIn.

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Over the past few weeks, I’ve been using this blog to discuss various ways of financing a business, whether a startup or an ongoing enterprise. One question that seems to be on the minds of my clients and readers of this blog is the lowdown on SBA financing (i.e., financing under the auspices of the U.S. Small Business Administration, which is an agency of the Federal government). So here’s my take on it.

First off, let me clarify a widespread misconception: the SBA does NOT make loans to small businesses. Rather, the SBA guarantees a portion of a loan made by a bank to a small business, as long as the bank participates in the SBA program and adheres to SBA guidelines when making and servicing the loan. By guaranteeing a portion (usually 50%) of the bank’s loan, the SBA eliminates some of the risk undertaken by the bank. This risk reduction is intended to make it easier for the bank to decide to lend to a startup or small business.

You may recall that a few weeks ago I wrote that getting a bank loan was virtually impossible for a startup business. So, can the SBA’s guarantee help a startup get a bank loan? The answer is “theoretically, yes.” I hate to wax metaphysical in my weekly blog, but in this instance it’s sort of unavoidable. Allow me to explain.

There are essentially two types of loan programs for which the SBA will provide a loan guarantee:  the Section 7(a) Loan and the Section 504 Loan. Let’s first look at the 7(a) loan.

The 7(a) loan can be used by a business for virtually any purpose (working capital, equipment & machinery, land & buildings, etc.). The 7(a) loan involves a sharing of risk between the bank and the SBA. The SBA will guarantee 50% of the loan, while the remaining 50% carries no SBA guarantee. If the borrower (the small business) defaults on the loan, the SBA will make good on the SBA guaranteed portion of the loan by indemnifying the bank for 50% of the bank’s loss. Which means that the bank is still on the hook for the remaining 50% of the loan, which is the portion not guaranteed by the SBA. 

Hence, the “theoretical” availability of the SBA loan to small businesses. Since the bank is still on the hook for at least 50% of the loan in the event the borrower defaults, the bank will still require the borrower to meet all the same credit and lending criteria it would have had to meet were the loan NOT guaranteed by the SBA. Which brings us full circle back to my admonition that getting bank financing for a startup business is difficult. While in theory the SBA guarantee can make it more palatable for a bank to make a loan to a startup, in reality it’s still tough going, especially in “Great Recession” America.

And by the way: if the business defaults on the loan, it is legally liable to both the SBA and the bank for the defaulted loan. The SBA and the bank can (and you can bet your life they will) sue the company after a default. They can also sue the owners personally, if the owners provided additional guarantees. If being on the business end of a lawsuit by the Federal government and a major bank isn’t palatable to you, don’t default on an SBA loan.

Now, a brief word about the logistics of starting the SBA Loan process. Virtually any major bank, and most of the local and regional banks, participate in the SBA loan program. There’s an excellent chance that if you walked into your local bank branch and inquired about SBA loans, they’d direct you to a loan officer who handles them. There’s not much mystery to it. 

Next week, in Part II of this discussion on SBA funding, I’m going to discuss the 504 loan, which is the more complex of the SBA loans. I’ll also have some additional comments on SBA loans and some thoughts on a couple of other SBA programs that don’t involve loans.

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