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Sources of Capital: Government Agencies (SBA)

Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez, John P. Funkhouser et al


This section is a compilation of content about the Small Business Administration from its web site at www.sba.gov, annotated with the authors' comments.

The U.S. Small Business Administration (SBA) is an independent agency of the executive branch of the federal government. It is charged with the responsibility of providing four primary areas of assistance to American small businesses. These are: advocacy, management, procurement, and financial assistance. Financial assistance is delivered primarily through the SBA's business loan programs, investment programs, disaster loan programs, and bonding for contractors. Here we provide an overview of the programs that relate to the funding of emerging growth and middle-market companies. The SBA offers numerous loan programs to assist small businesses. It is important to note, however, that the SBA is primarily a guarantor of loans made by private and other institutions.

SBA's Business Loan Programs

The SBA administers three separate, but equally important, loan programs. The SBA sets the guidelines for the loans, while its partners (lenders, community development organizations, and microlending institutions) make the loans to small businesses. The SBA backs those loans with a guarantee that will eliminate some of the risk to the lending partners. The agency's loan guarantee requirements and practices can change, however, as the government alters its fiscal policy and priorities to meet current economic conditions. Therefore, past policy cannot always be relied upon when seeking assistance in today's market.

Federal appropriations are available to the SBA to provide guarantees on loans structured under the agency's requirements. With a loan guarantee, the actual funds are provided by independent lenders who receive the full faith and credit backing of the federal government on a portion of the loan they make to small business.

The loan guarantee that SBA provides transfers the risk of borrower nonpayment, up to the amount of the guarantee, from the lender to the SBA. Therefore, when a business applies for an SBA loan, it is actually applying for a commercial loan, structured according to SBA requirements, which receives an SBA guarantee.

In a variation of this concept, community development organizations can get the government's full backing on their loan to finance a portion of the overall financing needs of an applicant small business.

SBA's Investment Programs

In 1958 Congress created the Small Business Investment Company (SBIC) program. SBICs, licensed by the Small Business Administration, are privately owned and managed investment firms. They are participants in a vital partnership between government and the private sector economy. With their own capital and with funds borrowed at favorable rates through the federal government, SBICs provide venture capital to small independent businesses, both new and already established. SBICs act as other venture capital firms, however with a different source of funding, which places some restrictions on structure.

All SBICs are profit-motivated businesses. A major incentive for SBICs to invest in small businesses is the chance to share in the success of the small business if it grows and prospers. (Note: the SBIC program has recently undergone significant changes and the entire program is in somewhat uncertain territory).

SBA's Bonding Programs

The Surety Bond Guarantee (SBG) Program was developed to provide small and minority contractors with contracting opportunities for which they would not otherwise bid. The SBA can guarantee bonds for contracts up to $2 million, covering bid, performance, and payment bonds for small and emerging contractors who cannot obtain surety bonds through regular commercial channels.

SBA's guarantee gives sureties an incentive to provide bonding for eligible contractors, and thereby strengthens a contractor's ability to obtain bonding and greater access to contracting opportunities. A surety guarantee, an agreement between a surety and the SBA, provides that the SBA will assume a predetermined percentage of loss in the event the contractor should breach the terms of the contract.

The New Markets Venture Capital (NMVC) Program is a developmental venture capital program designed to promote economic development and the creation of wealth and job opportunities in low-income geographic areas and among individuals living in such areas.

Basic 7(a) Loan Guarantee

The 7(a) Loan Guarantee Program serves as the SBA's primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. It is also the agency's most flexible business loan program, since financing under this program can be guaranteed for a variety of general business purposes.

Loan proceeds can be used for most sound business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation, and new construction), leasehold improvements, and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets. More information can be obtained at www.sba.gov/financing/sbaloan/7a.htm.

Certified Development Company (CDC), a 504 Loan Program

The 504 Loan Program provides long-term, fixed-rate financing to small businesses to acquire real estate or machinery or equipment for expansion or modernization. Typically a 504 project includes a loan secured from a private-sector lender with a senior lien, a loan secured from a CDC (funded by a 100 percent SBA-guaranteed debenture) with a junior lien covering up to 40 percent of the total cost, and a contribution of at least 10 percent equity from the borrower. The maximum SBA debenture generally is $1 million (and up to $1.3 million in some cases).

The maximum SBA debenture is $1,000,000 for meeting the job creation criteria or a community development goal. Generally, a business must create or retain one job for every $50,000 provided by the SBA. The maximum SBA debenture is $1.3 million for meeting a public policy goal. The public policy goals are:

  • Business district revitalization.
  • Expansion of exports.
  • Expansion of minority business development.
  • Rural development.
  • Enhanced economic competition.
  • Restructuring because of federally mandated standards or policies.
  • Changes necessitated by federal budget cutbacks.
  • Expansion of small business concerns owned and controlled by veterans.
  • Expansion of small business concerns owned and controlled by women.

Proceeds from 504 loans must be used for fixed-asset projects such as: purchasing land and improvements, including existing buildings, grading, street improvements, utilities, parking lots, and landscaping; construction of new facilities or modernizing, renovating, or converting existing facilities; or purchasing long-term machinery and equipment. The 504 Program cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing.

Interest rates on 504 loans are pegged to an increment above the current market rate for 5-year and 10-year U.S. Treasury issues. Maturities of 10 and 20 years are available. Fees total approximately 3 percent of the debenture and may be financed with the loan. Generally, the project assets being financed are used as collateral. Personal guaranties of the principal owners are also required. To be eligible, the business must be operated for profit and fall within the size standards set by the SBA. Under the 504 Program, the business qualifies as small if it does not have a tangible net worth in excess of $7 million and does not have an average net income in excess of $2.5 million after taxes for the preceding two years. Loans cannot be made to businesses engaged in speculation or investment in rental real estate. Additional information can be obtained at: www.sba.gov/financing/sbaloan/cdc504.htm.

Microloan, a 7(m) Loan Program

The Microloan Program provides shortterm loans of up to $35,000 to small businesses and not-for-profit childcare centers for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery, and/or equipment. Proceeds cannot be used to pay existing debts or to purchase real estate. The SBA makes or guarantees a loan to an intermediary, who in turn, makes the microloan to the applicant. These organizations also provide management and technical assistance. The microloans themselves are not guaranteed by the SBA. The microloan program is available in selected locations in most states. This program is delivered through specially designated intermediary lenders (nonprofit organizations with experience in lending and in technical assistance). Additional information can be obtained at www.sba.gov/financing/sbaloan/microloans.htm.

Loan Prequalification

The SBA provides a loan prequalification program that allows business applicants to have their loan applications for $250,000 or less analyzed and potentially sanctioned by the SBA before they are taken to lenders for consideration. The program focuses on the applicant's character, credit, experience, and reliability rather than assets. An SBA-designated intermediary works with the business owner to review and strengthen the loan application. The review is based on key financial ratios, credit and business history, and the loan-request terms. The program is administered by the SBA's Office of Field Operations and SBA district offices. This program is delivered through nonprofit intermediaries such as small business development centers and certified development companies operating in specific geographic areas. Additional information can be obtained at: www.sba.govfinancing/sbaloan/prequalification.htm.

Export Working Capital

The Export Working Capital Program (EWCP) was designed to provide short-term working capital to exporters. The EWCP supports export financing to small businesses when that financing is not otherwise available on reasonable terms. The program encourages lenders to offer export working capital loans by guaranteeing repayment of up to $1.5 million or 90 percent of a loan amount, whichever is less. A loan can support a single transaction or multiple sales on a revolving basis.

Designed to provide short-term working capital to exporters, the EWCP is a combined effort of the SBA and the Export-Import Bank (Ex-Im). Ex-Im could assume country risks the private sector is unable or unwilling to accept. The two agencies have joined their working capital programs to offer a unified approach to the government's support of export financing. The EWCP uses a one-page application form and streamlined documentation with turnaround usually 10 days or less. A letter of prequalification is also available from the SBA.

In addition to the eligibility standards listed later, an applicant must be in business for a full year (not necessarily in exporting) at the time of application. SBA may waive this requirement if the applicant has sufficient export trade experience. Export management companies or export-trading companies may use this program; however, title must be taken in the goods being exported to be eligible.

Most small businesses are eligible for SBA loans; some types of businesses are ineligible and a case-by-case determination must be made by the agency. Eligibility is generally determined by business type, use of proceeds, size of business, and availability of funds from other sources. The proceeds of an EWCP loan must be used to finance the working capital needs associated with a single or multiple transactions of the exporter.

Proceeds may not be used to finance professional export marketing advice or services, foreign business travel, participation in trade shows, or staffing U.S. support in overseas operations, except to the extent such expenses relate directly to the transaction being financed. In addition, proceeds may not be used to make payments to owners, to pay delinquent withholding taxes, or to pay existing debt.

The applicant must establish that the loan will significantly expand or develop an export market, it is currently adversely affected by import competition, will upgrade equipment or facilities to improve competitive position, or is able to provide a business plan that reasonably projects export sales sufficient to cover the loan.

SBA guarantees the short-term working capital loans made by participating lenders to exporters. An export loan can be for a single or for multiple transactions. If the loan is for a single transaction, the maturity should correspond to the length of the transaction cycle with a maximum maturity of 18 months. If the loan is for a revolving line of credit, the maturity is typically 12 months, with annual reissuances allowed two times, for a maximum maturity of three years.

There are four unique requirements of the EWCP loan:

  1. An applicant must submit cash flow projections to support the need for the loan and the ability to repay.
  2. After the loan is made, the loan recipient must submit continual progress reports.
  3. SBA does not prescribe the lender's fees.
  4. SBA does not prescribe the interest rate for the EWCP.

For those applicants that meet the SBA's credit and eligibility standards, the agency can guarantee up to 90 percent of loans (generally up to a maximum guarantee amount of $1.5 million). A borrower must give the SBA a first security interest equal to 100 percent of the EWCP guarantee amount. Collateral must be located in the United States.

International Trade Loans

If your business is preparing to engage in or is already engaged in international trade, or is adversely affected by competition from imports, the International Trade Loan Program may be available for your company.

The applicant must establish that the loan will significantly expand or develop an export market, and that the applicant is currently adversely affected by import competition, will upgrade equipment or facilities to improve competitive position, or is able to provide a business plan that reasonably projects export sales sufficient to cover the loan. Although most small businesses are eligible for SBA loans, some types of businesses are ineligible and a case-by-case determination must be made by the agency.

The proceeds of an SBA international trade loan may be used to acquire, construct, renovate, modernize, improve, or expand facilities and equipment to be used in the United States to produce goods or services involved in international trade, and to develop and penetrate foreign markets. Proceeds of this type of loan cannot be used for debt payment.

Loans for facilities or equipment can have maturities of up to 25 years. For the international trade loan, the SBA can guarantee up to 85 percent of loans of $150,000 and less, and up to 75 percent of loans above $150,000. The maximum guaranteed amount is $1,250,000. Only collateral located in the United States and its territories and possessions is acceptable as collateral under this program. The lender must take a first lien position (or first mortgage) on items financed under an international trade loan. Additional collateral may be required, including personal guarantees, subordinate liens, or items that are not financed by the loan proceeds.

Defense Economic Transition Assistance

The SBA's Defense Economic Transition Assistance (DETA) Program is designed to help eligible small business contractors to make the transition from defense to civilian markets.

A small business is eligible if it has been detrimentally impacted by the closure (or substantial reduction) of a Department of Defense installation, or the termination (or substantial reduction) of a Department of Defense program on which the small business was a prime contractor, subcontractor, or supplier at any tier. In addition, a business can be deemed eligible if it is located in a community that has been detrimentally impacted by these same actions.

The DETA program provides financial and technical assistance to defense- dependent small businesses that have been adversely affected by defense reductions. The goal of the program is to assist these businesses to diversify into the commercial market while remaining part of the defense industrial base. Complete information on eligibility and other rules is available from each SBA district office.

This program can be used in conjunction with both SBA's 7(a) and 504 loan programs and generally follows the provisions of each program. In order to be eligible for this program, small businesses must derive at least 25 percent of their revenues from Department of Defense or defense-related Department of Energy contracts or subcontracts in support of defense prime contracts in any one of five prior operating years.

Small businesses interested in utilizing this program must also meet at least one of the program's policy objectives:

  • Job retention-retains defense employees.
  • Job creation-creates job opportunities and new economic activities in impacted communities.
  • Plant retooling and expansion-modernizes or expands the plant and enables it to remain available to the Department of Defense.

U.S. Community Adjustment and Investment Program (CAIP)

CAIP is a program established to assist U.S. companies that are doing business in areas of the country that have been negatively affected by the North American Free Trade Agreement (NAFTA). Funds administered by the U.S. Department of the Treasury allow for the payment of fees on eligible loans. These fees include the 7(a) Program guarantee fee (and subsidy), the 504 Program guarantee, CDC fees, and lender fees. Depending on the loan size, the fees can be sizable.

The CAIP works with the SBA in both their 7(a) Loan Guarantee Program and 504 Loan Program to reduce borrower costs and increase the availability of these proven business assistance programs. CAIP can be used with both the 7(a) and 504 loan programs.

To be eligible, certain criteria must be met; for example, the business must reside in a county noted as being negatively affected by NAFTA, based on job losses and the unemployment rate of the county; this was recently expanded to allow for granting eligibility to defined areas within a county (which will allow SBA to react quickly in offering to provide assistance when, for example, a plant closes).

In addition, there is a job creation component. For 7(a) loans, one job has to be created for every $70,000 that SBA guarantees. For 504 loans, one job has to be created for every $50,000 that SBA guarantees. Currently, more than 230 counties in 29 states are designated as eligible.

Pollution Control Loan Program

Pollution Control Loans are 7(a) loans with a special purpose of pollution control. The program is designed to provide financing to eligible small businesses for the planning, design, or installation of a pollution control facility, including recycling. This facility must prevent, reduce, abate, or control any form of pollution.

This program follows the 7(a) guidelines with the following exception: Use of proceeds must be for fixed assets only.

CAPLines Loan Program

CAPLines is the umbrella program under which the SBA helps small businesses meet their short-term and cyclical working capital needs. A CAPLines loan, except the Small Asset-Based Line, can be for any dollar amount that does not exceed SBA's limit. (See the 7(a) Loan Guarantee Program for more information on the SBA's basic requirements.)

There are five short-term working capital loan programs (lines of credit) for small businesses under the CAPLines umbrella:

  1. Seasonal Line. This line is an advance against anticipated inventory and accounts receivable help during peak seasons when businesses experience seasonal sales fluctuations. Can be revolving or nonrevolving.
  2. Contract Line. This line finances the direct labor and material cost associated with performing assignable contract(s). Can be revolving or nonrevolving.
  3. Builders Line. If you are a small general contractor or builder constructing or renovating commercial or residential buildings, this can finance direct labor and material costs. The building project serves as the collateral, and loans can be revolving or nonrevolving.
  4. Standard Asset-Based Line. This is an asset-based revolving line of credit for businesses unable to meet credit standards associated with long-term credit. It provides financing for cyclical growth, recurring, and/or short-term needs. Repayment comes from converting short-term assets into cash, which is remitted to the lender. Businesses continually draw from this line of credit, based on existing assets, and repay as their cash cycle dictates. This line generally is used by businesses that provide credit to other businesses. Because these loans require continual servicing and monitoring of collateral, additional fees may be charged by the lender.
  5. Small Asset-Based Line. This is an asset-based revolving line of credit of up to $200,000. It operates like a standard asset-based line except that some of the stricter servicing requirements are waived, provided that the business can consistently show repayment ability from cash flow for the full amount.

Except for the Small Asset-Based Line, CAPLine loans follow the SBA's maximum loan amounts. The Small Asset-Based Line has a maximum loan amount of $200,000. Although most small businesses are eligible for SBA loans, some types of businesses are ineligible, and a case-by-case determination must be made by the agency. Eligibility is generally determined by type of business, size, and use of proceeds.

Each of the five lines of credit has a maturity of up to five years; however, because each is tailored to an individual business's needs, a shorter initial maturity may be established. CAPLines funds can be used as needed throughout the term of the loan to purchase assets, as long as sufficient time is allowed to convert the assets into cash at maturity.

Holders of at least 20 percent ownership in the business are generally required to guarantee the loan. Although inadequate collateral will not be the sole reason for denial of a loan request, the nature and value of that collateral does factor into the credit decision.

The above material is adapted from The Handbook of Financing Growth: Strategies and Capital Structure by Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez, John P. Funkhouser. Copyright ©2005.This material is used by permission of John Wiley & Sons, Inc.