Growth | August 2011 | By John Morell

SBA Loans to the Rescue?

Small Business Administration loans can help quick-serve operators get the financing they need to open a new store, but the process isn’t easy.

The Small Business Administration helps fund new business owners.
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Most businesses can’t get off the ground without a little financial help, a fact that is especially true in the quick-serve industry. Opening a quick serve, be it through buying a franchise or starting a new concept, requires cold hard cash, meaning any entrepreneur who intends to be a player in the industry has to become friendly with a bank or a broker.

But for those who are new to the process—or for those looking to go through the process again—one of the first terms they’ll likely hear is SBA. That’s especially true after President Obama signed the Small Business Act in September.

The Small Business Administration was formed in 1953 to assist the startup and growth of small enterprises that were taking off in the post-war period with loans and grants. Countless businesses have received a hand from the agency over the years, and when the Small Business Act was signed, operators were given access to even higher loan amounts in an effort to jumpstart business growth.

But misperceptions abound regarding what exactly the SBA does.

“When I’m talking to a prospective business owner, he or she often has no idea about how SBA programs work,” says Denise Beeson, a business loan consultant based in Santa Rosa, California. “There’s always been this misperception out there that the SBA directly loans businesses money, which is far from what it does.”

Instead, the SBA provides a varying percentage of loan guarantees for banks that lend under the agency’s guidelines, which theoretically makes it easier for the bank to loan capital for a startup or expansion.

There are two programs that cover the bulk of SBA-guaranteed loans: 504 and 7(a). A 504 loan is designated for construction and real estate improvements, as well as machinery and equipment; it can go up to $5 million with a 20-year term and has a fixed interest rate. Loans from the 7(a) category go for up to $5 million and can be used for the same purposes as money from a 504 loan, as well as for working capital and lines of credit.

The bank processes and analyzes an application, then, if it clears the loan officer’s desk, it’s sent to the SBA, which must give its OK. Should the borrower default on an approved loan, the SBA repays the bank 75–90 percent of the loan amount.

“For the bank, it’s a win-win,” Beeson says. “They get a solid borrower, and if he happens to default, they get their money back.”

For the borrower, an SBA loan can be had for as little as zero down if there’s substantial collateral or equity in the business, and for up to 40 percent for startups. Rates are typically prime plus 3 percent, as well as loan fees of 1–2 percent.

“It’s really the best lending program available for franchises,” says Dan Rowe, president of Fransmart, an Alexandria, Virginia–based consulting firm. “If you can get in, it’s a great deal.”

Of course, “getting in” can be a big roadblock, especially in these days of tighter credit. “I consider myself extremely fortunate,” says Tom Jones, co-owner with his sister of four Cousins Subs franchises in the Milwaukee area, who used SBA loans to finance his stores. “For my first store, I borrowed a little from family and then put 10 percent down. It was a very smooth, easy process. When we bought our third and fourth stores, we were able to show that we were profitable and we didn’t have to put anything down; in fact, we received an extra 10 percent for working capital.”

After credit tightened in 2009, Jones attempted to gain financing for a fifth store. “The requirements were much different,” he says. “Even though we had proven success, they wanted to see us put 40 percent down, which didn’t work for us, at least not at that time.”

An SBA loan can be had for as little as zero down if there’s substantial collateral or equity in the business, and for up to 40 percent for startups.

While the SBA guarantee is supposed to induce banks to lend, the criteria they use have toughened up. Credit reports, both personal and business, are scrutinized for loan worthiness, and a thorough check of the business’ books or a business plan for startups will be examined for the operator’s ability to make payments.

One key hold-up for many people seeking SBA help is the requirement for collateral. “You’re expected to keep something substantial on the table,” Beeson says. “In the past with startups, people often put up the equity in their real estate as collateral. Now, however, as much of that equity has vanished, their options are severely limited.”

Also at issue are credit reports, as many operators struggle with business and personal credit issues that have plagued them during the Great Recession.

“Quite a few successful business people have had to handle late payments or even bankruptcies during this period that have affected their borrowing ability today,” says Don Johnson, president of Diamond Financial, a business loan broker in West Keansburg, New Jersey.

Finally, character also plays a role in whether or not the bank writes an operator a check. “They’re going to want to know not just your business acumen, but what kind of person you are,“ Beeson says. “Do you have any felonies? DUIs? Are there any judgments or lawsuits against you? These obviously hurt your chances.”

Often, businesses in the food and hospitality industries also have a few more hoops to jump through in order to qualify. “Some banks just do not like food businesses, even those backed by strong national franchises,” Beeson says. “It’s a tough industry, and they want to make sure you’re going to turn a profit and pay on your loan.”