As SBA lending options become more advantageous for service-based brands, let’s debunk common myths and clear up confusion surrounding this smart funding option with insight from a leading lender in this space.
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We want to give our franchise brands, brokers, and consultants accurate information as we outline and discuss the different SBA loan programs and what a bank looks for specifically for this loan size, and what challenges lenders face, and what funding options are available for candidates.
For anyone who has worked with clients in the last few years pursuing the $150,000 loan size and under, you probably have heard the name Fred Crispin or the name United Midwest Savings Bank, one of the leading banks specializing in funding these size loans. Our own Eric Scheterman was able and happy to sit down for a webinar with Fred to gain insight on everything franchisors, borrowers, and lenders should know about this often misunderstood loan.
What is SBA Lending for $150k & Under Really?
Sometimes referred to as the 7a loan or the express loan, the SBA $150k and under loan is in fact also commonly an express loan. Most of the loans within the franchise industry for the SBA are $150,000 and under technically are 7a loans but have adopted this name of express, but it's not really in theory being done as an express loan.
What is the Guarantee?
A guarantee for the lender means a bank can look at an opportunity and feel good about the loan, but feel even better because they have a guarantee on the backend from the government through the SBA program to continue to incentivize and put money into small business America. That is a guarantee should there be a default on that loan and provided that they have a good lending decision base.
30,000 ft. Overview: Terms & Conditions
The SBA says that any loan of $25,000 and below doesn't require collateral. Their personal computer can go from any loan in excess of $25,000 to up to $150,000. The SBA allows banks to take a lean on the borrower's business assets but not on their personal residence or anything else.
As far as equity injection from the borrower versus the loan value, is there a firm number, or does it vary, and how much is a borrower being asked to inject that total project costs? As Crispin describes it, "The SBA says the borrower has to inject a minimum of 10% of the total project cost, but a $150,000 loan basically would indicate that you've got a borrower with a total project cost of at least $166,600, and we're putting in $150,000 the borrower's putting in $16,666. The minimum is 10% on any startup." When loans are smaller, and total projects are a little larger, the franchise fee that a client might pay out of pocket will usually almost satisfy or at least be a chunk of that borrower's equity injection.
Franchisors don't typically love waiting for the loan to be closed to get the balance of their franchise fee, and some may think they can just pay that out of pocket and reimburse themselves after the loan comes in. As far as the borrower paying it upfront and repaying themself, Crispin says no. The SBA says once you put that money into the business, you can't turn around and pay yourself back. "That remains in equity. Once equity goes in, it has to remain,” notes Crispin.
When Should It Be Used, and When Should It Be Avoided?
A big reason that many franchisors, consultants and everyone in our industry working with loan sizes up to this amount on project costs considers this a popular program is because it's being sold as a "small percentage down, no collateral" loan. It's not "no collateral"; it's that banks are not required to take personal collateral.
Franchise brands have in their agreement that the franchisor has the right to certain business assets, so should there be a default within the franchise or a violation of the franchise agreement? And what about franchise brands where they're starting a home-based service business; there are not a ton of business assets involved, so how would that work within the program?
Crispin enlightens us that "with the service-based businesses, we've learned over the years that if you properly capitalize that business and make sure the borrower's got enough money to get it ramped up to get through that startup period, then they can be successful and generate sufficient income to pay the loan back."
Working capital loans have become more popular recently; there weren't always a lot of brick and mortar opportunities that could be built for $150,000 and under, but now we see some concepts that are smaller square footage. What if a total project is $150,000 and under, but it is brick and mortar, how does that work?
Crispin provides that they should "Most likely, find another lender or your local bank because the borrower would be so upset with us by the time we put in appraisal fees, EPA phase ones, title insurance, and everything else we'd have to get involved in the deal that the outside cost would be more than what they would be comfortable with. These loans are not primarily for building out brick and mortar businesses."
Best Use Cases for the Loan?
You can use the loan proceeds for working capital as well as to pay the owner's salary, manager's salary, and marketing. One of the things borrowers should do in their projections for banks is to show a salary sufficient to keep their debt-to-income ratios in line. In other words, they've still got to be able to pay the home mortgage, car payments, and buy food as well as make sure they're paying themself enough to keep all credit in good shape.
How should franchisors look to structure the loan with taking a deposit, and how should they set up the note? For the franchisor, it should be a deposit of $15,000 - $20,000, or whatever they want to put down, and then from there, set up in an account's receivable. "Stay away from notes receivable right now because that's a big problem with the SBA,” warns Crispin.
What Are Lenders Looking for? In Candidates? In Brands?
What does an ideal candidate for this loan look like? To start with, they've got to have good credit. The SBA adopted the Fair Isaac Small Business Model for all loans $350,000 and below, which looks heavily at personal credit, as well as industry risk time and business startups go through a startup module it looks at the percentage of revolving available to the borrower, have they maxed out on all credit cards, do they have some fallback room, how many people have pulled their credit in the last year two years, excessive crediting inquiries, and more are delved into.
Above and beyond that, borrowers should have the liquidity to be able to put their 10% equity injection in from their personal savings, checking, marketable securities, some IRAs, or 401k. Gifts from immediate family members are allowed, but they can't get a gift from a close friend.
On the backside, they look for a borrower at the very least to have at least $50,000 in post-closing liquidity after they put their 10% in and we get the loan funded.
When it comes to a candidate's post-closing liquidity, Crispin tells us, "That's extremely important to us. We go to the Coleman Report, which publishes a publication once a year, then it'll give you the default rates for the various franchises. If we're dealing with a franchise that's got a high default rate then we're going to be looking for a lot more post-close liquidity, or if you've got a brand new franchise that doesn't have a track record, we want to look at borrowers that have post-close liquidity of at least $150,000 until we can establish some kind of track record that this franchise is a concept that's going to work well."
With the Fico Score, what is the minimum? Crispin says, "675 and up is what I tell people to score in that model. The up depends on the risk of that franchise. If you're talking about a startup veterinary clinic, probably 675 or a little bit less. If you're talking about a startup restaurant, you probably need to be at 775 and up."
Liquidity, Liquidity, Liquidity. Post-Closing?
The biggest confusion is that liquidity is not money the borrower is putting into the business, and it's not money they're giving to the bank; this is the money that the bank needs to see. Crispin explains that "while they're ramping up the business, they should not be pulling money out of business before it can support it, and they should not be siphoning some of those loan proceeds to cover personal debt service. We want to see that this person has money left over to operate this business as it was structured. In this program, it's not the equity injection that has to be $50,000, it could be that borrower injecting $10,000, $15,000 or $20,000, but they need to have access to it in liquid, marketable securities, checking, savings or retirement funds that meet or exceed $50,000."
Does post-closing liquid requirement change, and how is all of this affected by household income, employment, lack of employment, or if both spouses are unemployed? If they have no current income and they're not maintaining a current job, then the bank is going to look at their household debt on a monthly basis and the amount they need to pay themselves out of the loan as they ramp up so that they keep their credit good, don't fall behind on mortgage payments or car payments, etc. If there's still some sort of income coming in to support debt service, that $50,000 is still the minimum.
Just a note, with higher volumes and the average loan size, you could have 80 packages where you don't have to worry about gifts co-signing marginal scores, which are more attractive to banks. The more challenging somebody makes a package, the bank is going to take notice.
For franchises that have less than 50 locations open, that's viewed as an emerging business, but it's not that these candidates can't use this loan, but they will likely need a stronger borrower, specifically on the liquidity side.
As a note, a great way to create post-closing liquidity where there might not be some is through a rollover funding strategy with any of the tremendous funding providers that offer this expertise, such as Benetrends, who is the primary funding source for a lot of franchisors when it comes to the rollover-as-business-startup (ROBS) and assisting people in the SBA environment.
What Are Some of the Biggest Assumptions about This Loan Size?
How does it work for brands that don't have business assets? As Crispin explains for United Midwest Savings Bank, "Our typical candidate is operating from home, which banks are fine with, a service-based business. A prime example would be a Molly Maids franchise. They will have a couple of vacuum cleaners and feather dusters, nothing that a lender would typically be excited about taking into liquidation, but we're fine with that because we've learned over the years that if you properly capitalize that business, they can go out and generate sufficient income to pay us back and that's what that's the key."
So emerging brands are welcome; it's just a matter of looking for candidates. If you've got a borrower getting involved in a franchise that's technical in nature and requires a specific license, i.e., an electrical franchise, "we're going to require that borrower to be licensed in that field. We want to make sure they're the master electrician, not hiring somebody to handle that. We want our borrowers to be involved and maintain that license so that they can run the business fine on their own if things do go awry.
Is there such a thing as being overqualified for this loan? Credit Elsewhere means the borrower has the means in liquid assets, true liquid assets: cash, checking, savings, or marketable securities (not retirement accounts because they're not a true liquid asset). If the borrower does have true liquid assets sufficient that they could fund themself and they don't need a government loan, the general rule right now is if they have more than $500,000 in personal true liquid assets, they can most likely get credit elsewhere and don’t need the SBA's involvement.
Funding Timelines: What Helps? What Hurts?
What is the timeline from start to finish and the process from application to underwriting to closing to funding? Crispin gives us the details stating: "The application approval is the same day we get the simple loan application that we have on SBA.com. It's a PDF fillable form they can download, fill it out, save, and then submit. It gets uploaded to us and then into a platform that will pull their credit score through Experian and communicate everything about them, their business, and their credit to Fair Isaac, which scores them through a pass-fail system.
Crispin continues, "If you score above the cutoff that we have set in the model we can approve it then we approve it if it scores above the cutoff, we assign it to a packager who, that same day or the following day, will be in touch with the borrower to get the remaining information and forms. Then, the borrower is emailed a checklist of everything we're going to need to move that loan down the pipeline."
Once the bank gets everything into that file that we need for SBA, the loan can move it into underwriting, and the underwriters will pick that file up, review it for compliance with SBA, and create the credit memo the SBA requires. Then they move it into closing. The closers will pick that file up, finish up any documentation, usually get the insurance certificates, and prepare the closing documents with the borrower through DocuSign electronically.
Start to finish is right now, Crispin states it takes "about 60 days for the borrower. So getting the information is the most significant part; if the borrower takes another ten days to submit documentation items, it can drag out the process."
What Can Slow Down or Speed Up the Loan Process?
As Crispin tells us, "borrowers that are ready actually to move and are motivated to get documentation into the lender as it's required and doesn't try to tell us how to package the loan, but trusts our experience with the SBA. The ones who know what we're looking for and can give us what we need in a timely fashion will allow us to move as quickly as possible."
Another way to speed up the process? Crispin states that the bank needs the basic information and what industry they're going to be in, and the borrower needs to have formed their corporation, LLC, partnership, or otherwise. The formal entity needs to be formed with a tax id number set up.
For many franchisors, it can be beneficial to have relationships with funding partners, whether it be with banks, Benetrends, or any funding partner that knows what these banks are looking for. Choose the path of least resistance. Have partnerships with people who know what banks are looking for to tell you upfront what you need to help facilitate this franchise funding process.
If you are ready to learn more about the SBA $150k and under loan programs, schedule a consultation to learn more.
Please Note: The Cares Act funds which are slated to run out September 30 is the fiscal year for the SBA. The Cares Act program was giving a lender a 90% guarantee but in addition to it waived the guarantee fees that a small loan borrower had to pay.
The SBA has already put out a notice that effective October 1, guaranteed fees for small loans $150,000 and below will be waived again for the following year, so borrowers are not going to have to pay the two guarantee fee that stays in place. The first three months of monthly payments being made by the SBA goes away with the end of the Cares Act, but the guarantee fee waiver is still in place, which is a very good thing.
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