Einstein: SBA = 7(a) + CDC/504.
Henry Ford once said, “Any customer can have a car painted any color that he wants so long as it is black.”
As many small and medium size business owners know, Ford’s quote doesn’t apply to the options that seem available when looking for a loan. The list can overwhelm: Interested in an SBA loan? In that case, which is it: 7(a), CDC/504, or microloan? How about an BLOC? If not commercial-bank ready, maybe you could use an ACH loan or PO funding? If the choices are starting to look like an incoherent word scramble or a computed-generated password, don’t despair: In this brief article, I’ll help you decipher the the basics of the loan landscape. Alternatively, you can scroll to the bottom, contact me, and I’ll work through it all with you.
SBA loans are the cheapest sources of debt financing for small businesses. The Small Business Administration guarantees 75% of principal for loans over $150k in the case of 7(a) loans and up to 40% for 504 loans. 7(a) loans have rates that currently top out at 6.75% for loans greater than $50k, and they can be used for a variety of business purposes—equipment purchases, debt refinancing, and partner buyouts, for example. SBA 504 loans currently max out at around 4.6% and are used for real estate purchases.
These loans can be hard for a small business to get: You’ll need good credit, a steady operating history, and sufficient “interest coverage,” a piece of banker-speak that refers to your company’s ability to handle interest payments from cash flow and is measured by this equation: (Operating income + Depreciation + Amortization) / Interest Expense; this ratio probably shouldn’t be lower than 1.25x. You’ll also need to provide a personal guarantee and have the patience of a Good Samaritan because 1) the application makes IRS Form 1040 look like light reading, and 2) the approval process can take over a month.
If an SBA loan is the holy grail of small business loans, then a term loan is the Dead Sea Scrolls. Banks, marketplace lenders, and some non-bank lenders provide term loans to small businesses. A term loan gives the borrower a specific amount of money up front, has a specific repayment schedule (there can be monthly, quarterly, or semi-annual amortizations) and specific maturity (from one to at least ten years) usually with balloon payment, is usually secured, and can have a fixed or floating interest rate. They are often used to buy equipment. These loans can be hard for a small business to get from a commercial bank, but marketplace lenders sometimes have easier lending criteria. Rates range from single digits to about 30%.
Business Line of Credit
A line of credit, or revolver, is an arrangement with a lender that sets an established maximum availability for the borrower, who can draw down and repay as often as needed for the life of the arrangement. It’s also called a revolver because you can borrow then repay, borrow then repay, in a loop like the plot to a Philip Dick novel. Rates range from single digits to 40% or more.
If the options above aren’t available to you but you invoice your customers, then factoring might be the best route for you because your customers’ ability to pay is what’s important, not your creditworthiness. The lender will effectively purchase receivables from you for, say, 80% of their value. When your customer pays the full invoice amount to the lender, you’ll get back the remaining 20% less a factoring fee (maybe 2%). The drawback to factor financing is that it can be expensive. In this example, if the customer pays in 30 days, the implied annual percentage rate (“APR”) is about 30%, but with higher/additional fees and a longer day count, the total cost moves considerably higher.
Purchase order (PO) financing
If your B2B business has decent margins (because this financing gets pricey) but doesn’t have the cash to buy the goods needed to fulfill a customer purchase order, then PO financing might be the way to go. The PO lender will pay your supplier to deliver the goods (typically finished goods) to you. After you then supply the goods to your customer, the PO lender will invoice your customer. If your customer immediately pays, then the PO lender will take a fee (2-5%, often increasing after 30 days, so APRs can hit triple digits) and return the balance to you. Things get trickier and the fees pile up if your customer gets invoiced and pays on 30, 60, or 90 day terms. In that case, if the PO lender doesn’t provide factor financing, a factoring company will advance the invoice for a fee, in the process paying the PO lender and you.
Merchant cash advance
One of your last options (presuming you’ve already exhausted FFF funding—friends, family, and fools), a merchant cash advance is a lump sum payment to you that is repaid with a percentage of your future credit/debit card sales. If you don’t rely on credit card sales, the advance can be structured as an “ACH loan,” in which the lender would be repaid by deducting its portion directly from your business’s checking account. You borrow here based on a factor rate: With a 1.5 rate, if you borrow $100k, you’d repay $150k. Continuing the example, if your arrangement assumes $85K in monthly credit sales and a 10% repayment rate, your APR is about 60%, which goes higher with hidden fees or increased sales (in the latter case, higher than anticipated sales result in you paying back the same amount in less time). APRs can hit the century mark pretty quickly here.
What to Do Next
If all this lender lingo leaves you lost, you’ve come to the right place: Contact us for help in cutting through the acronyms to figure out the smartest way to get your business funded or get the process started on your own by answering a few simple questions here.