So you have decided to add U.S. Small Business Administration (SBA) loans to your financial institution’s loan portfolio. The SBA program provides a nice way to help mitigate some of the risk that is found in some commercial loans. The risk is lowered with the guarantee provided by the federal government. So this should allow you to become involved in more loans and expand your loan portfolio.
But how do you go about finding good SBA prospects? There are several strategies you should follow to avoid the bad loans and find the good opportunities. We will first focus on what to not do.
Thou shalt not chase after every business start-up. An article in Forbes in January 2015 claims that 9 out of 10 business start-ups fail. An article in Inc. later that year cites that 96% of new businesses fail within 10 years. So new start-ups have between a 4-10% chance of still being around in ten years depending upon which article you believe. Most business loans are amortized over a longer period than 10 years so be aware of the very slim success ratio which will mean to be prepared to take losses. All start-ups should have strong capitalization and management experience.
Thou shalt not lend to a borrower that is not willing to put equity into a project. The SBA is not to alleviate prudent equity injections required for a business lending project. In fact, equity is a requirement. If you cannot trace the equity to hard cash or true equity in assets, and the borrower is not willing to put his stake into the project, walk away.
Thou shalt not just focus on the small deal. The average SBA loan in 2015 was $371,628. Many institutions turn their SBA ammo on only the smaller deal. But with the ceiling of a 7a SBA loan at $5,000,000, it makes sense to look at larger financing opportunities to use for the program.
Thou shalt avoid refinance opportunities. Refinancing under SBA has quite a few additional rules that must be followed. SBA is not a solution for refinancing debt for companies with bad operating performance. It can be used to help refinance debt that has an upcoming balloon, or can provide a payment savings of 10% or more.
Thou shalt avoid borrowers with prior losses to the U.S. Government, poor personal credit, and poor personal character. SBA is never to be used for a mitigant for these situations. You still need to maintain your standards for a SBA loan as you would on a non-SBA loan.
Thou shalt not attempt to use SBA for non-owner occupied real estate, non-profit, SBA restricted industries, or credit card refinance.
Thou shalt focus on good, well-run, small- to medium-sized businesses. Just because a business is a good performer does not mean that it is too good for the SBA. Many times these well-run companies are perfect for a SBA as they grow and need to take their company to the next level. Don’t just focus on the high-risk company that is a marginal player. Remember, the SBA provides a guarantee on a portion of the note, so you will have to accept a loss as well.
Thou shalt focus on business expansions, real estate, and equipment. SBA is not just for the unsecured operating line. It works best when there is an existing, well-run business, that is seeking to rise to the next level. This expansion may require a new facility, equipment purchase, or building expansion.
Thou shalt look for buyouts that make sense. SBA is a good tool for a business buyout financing, as it helps lower the risk to you. Good areas to focus on are professional companies that have an ongoing client list such as a doctor, dentist, or veterinarian. In many cases, the SBA provides a method that the young professional can take over an existing clinic as they build up their business. Make sure there is adequate equity that the buyer is putting into the project and there also may be a requirement the seller carry back some of the goodwill in a subordinate financing.
Thou shalt consider SBA when looking at restricted industries to your loan policy. If you have restrictions on hotels, restaurants, or contractors, using the SBA guarantee may help you provide financing to a good lending opportunity within those industries.
Thou shalt contact Pactola for help. When you have a SBA opportunity, contact us. We have several credit unions that use us as a Lender Service Provider with the SBA. We can help walk you through the process.