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The appropriate financing for any business will vary considerably based upon the $ amount of capital required. This article offers an overview of the best financing available based upon the amount of money required to properly capitalize any given business.
Financing a Business for $350,000 or Less
In 2014, the Small Business Administration (SBA) introduced the Small Loan Advantage loan program some lenders refer to as the SBA Express loan. After the “The Great Recession”, many homeowners lost their real estate equity which is used as collateral requirement for a SBA 7(a) loan approval in most cases. Consequently, many perspective borrowers were unable to secure financing because they lack the equity in their home required to collateralize their loan request. The SBA Express loan is capped at $150,000 to limit the lender’s risk since the borrower’s real estate collateral is not required and business assets are used to collateralize the SBA Express loan. Since the collateral used to secure an equipment lease is the equipment being financed and the collateral for the SBA Express loan is the equipment needed to operate the business, these 2 debt financing products are compatible!
Capital Leases – Leasing Equipment to Own
The most common financing option for the equipment needed to operate any business is a capital lease. The main purpose of a capital lease is to finance the equipment purchase while preserving the owner’s working capital. Franchisees can finance the purchase of their proprietary equipment, security systems, computer hardware & software, flooring, outdoor signage and other tangible items needed to run the business using an equipment lease. The owner(s) are required to personally guarantee equipment lease. The required down payment ranges from a lease payment up to 20% of the amount financed. Lease documentation fees may range from $95 to $495. Repayment terms typically range from 12 months up to 60 months. All payments are tax deductible, so these payments will lower business’s taxable income and, in turn, tax liability. Since the plan is to keep their equipment long term, a typical capital lease offers a $1.00 end of term purchase option.
Small Business Administration (SBA) Express Working Capital Loan
This government backed loan is designed to provide up to $150,000 of working capital to support the company until the business generates positive cash flow. The loan process 90 days to complete before the loan is funded. The SBA Express loan approval requirements are good personal credit & some liquid assets and the loan process requires attention to detail. If the use of the loan funds is to finance a new location, the loan can be approved in advance, however the funds will not be distributed by the bank until the new location has received a certificate of occupancy. This insures that the money will be used to operate the new business & will not be used to pay for build out expenses. The interest rate for this loan is calculated by starting with the prime rate as published in the Wall Street Journal which is currently 5.5%. The bank charges a 2.75% risk premium on this loan so the interest rate is 8.25% now. The repayment term is 10 years and there is no pre-payment penalty so if the franchisee is extremely profitable, the loan can be prepaid to save interest expense.
In conclusion, equipment leases and SBA Express loans are complementary products that will enable the owner of a business with good personal credit to finance the opening and expansion of a franchise. The best part about this financing combination of a SBA Express loan & equipment lease is that the collateral is your business assets… not your home … just your business assets!
Financing a Business for $350,000 or More
The SBA 7(a) Loan up to $5MM will provide financing ranging from 70% to 90% of the total project costs which typically includes the equipment, franchise rights (if any), organization costs, location buildout, deposits, inventory & operating working capital. The owners’ equity injection ranges from 10% to 30% of the total project cost and cannot be borrowed money such as a home equity loan. The borrowers must provide their resume(s) demonstrating industry experience, transferable management skills and/or related education. The collateral for the loan includes all business assets. Additional collateral is often required which is typically residential real estate only up to the loan $ amount. Good personal credit is required.
The loan repayment term is 10 years. A prepayment penalty, if any, typically ranges from 1-4% over the initial 4-year term. The interest rate is typically prime rate as published in the Wall Street Journal (5.5%) plus a risk premium typically 2.75% so the current rate offered is 8.25%. Closing Costs are approximately 3.5% of loan amount and are usually added to the loan amount.
Real Estate Acquisition
The SBA loan up to $5MM will finance up to 90% of the real estate acquisition cost. The owners’ equity injections are typically 10% of the acquisition cost of the real estate and cannot be borrowed money such as a home equity loan. The business must occupy at least 50% of the useable space which provides an opportunity to lease out up to 49% of the useable space. The collateral is real estate being purchased. Good personal credit is required. The loan repayment term is typically 25 years. The loan is fully amortized with no balloon payment. The interest rate is calculated starting with the prime rate (5.5%) plus a risk premium typically varies from 1.5% up to 2.75% based up the appraisal and the strength of the borrower. The closing cost is typically 3.5% of loan amount added to the amount financed at closing. The timing to close is 90 days and varies with bank work load, time for real estate appraisal & borrower responsiveness.
There are many benefits of the SBA 7(a) loan program to finance a new or expanding business. The business owner will have only one monthly debt payment amortized over the longest repayment term available with no significant prepayment penalty. The use of funds is nearly unlimited to any legitimate business purpose. Since the SBA 7(a) loan is backed by the federal government so it offers the best chance of an approval at the lowest APR available. Consequently, we recommend you strongly consider this form of financing for the wide variety of uses that this flexible loan product offers for business financing.
Paul Bosley, Managing Member
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