“It took me a while to really commit to the idea of starting my own business,” says Timothy Lu, a young adjunct professor at Pasadena City College in Pasadena, Calif. “I’m still paying off my student debt, and I didn’t want to add more debt to my existing load before I turned 25.”
Still, Lu has decided to open his own bubble tea (boba) shop this year with a friend in hopes to gain experience outside of the academic world. “We want to start a boba shop because it’s culturally significant to us and would entice Asian Americans to get more involved with their community,” says Lu. While they are still brainstorming business names, Lu has already begun exploring various initial funding models. “Ideally, we would fund entirely with crowdfunding to try and utilize our community and friends to get an emotional buy-in,” he says. “Applying for a Small Business Administration (SBA) loan is our last resort since we don’t want to go into institutional debt and also have to pay it off with interest. SBA loans are something we will consider when the time comes.”
While the stigma of millennials as avocado-eating, trendsetting hipsters remain at large today, they will also account for 75 percent of the workforce by 2025 and are starting their own businesses at almost twice the rate of previous generations. Millennials are also launching their businesses at a younger age, with the average entrepreneur being 27 years old, whereas the baby boomer generation saw an average age of 35 for entrepreneurs.
Despite the fact that the SBA loan was designed to help small businesses, Lu isn’t the only one to express concerns about taking out an SBA loan. According to a Wells Fargo study, 59 percent of millennials felt like they were unlikely to qualify for a loan or a line of credit due to the small size and the nature of their business.
“Unfortunately, there is a misconception about SBA loans,” says Wai-Chun Li, senior vice president and manager of East West Bank’s SBA lending department. “People often have the notion that getting an SBA loan is too time-consuming, tedious, or strict, because it’s linked to a government agency.” Li stresses the importance of entrepreneurs taking the initiative to talk to an SBA loan advisor to understand the specific financial benefits for their business. “My mission is to get people to understand that the loan is a business ally and a useful tool, not a last resort,” he says.
“Crowdfunding, venture capital, angel investors, etc., these are all good methods of funding,” says Li, “but don’t take SBA loans off the table without really exploring the options.”
With an SBA loan, a business owner would have 100 percent ownership over their business and have control over the direction, expenses and investments for the business. “You can be your own boss with an SBA loan," says Li. “Who wouldn’t want that?”
Repayment terms, down payments, and use of funds are flexible with an SBA loan. For example, with an SBA 7(a) loan, the funds could be used toward refinancing existing debt, buying land, improving inventory, marketing campaigns, etc. that could free up a lot of capital for the business owner.
“Honestly, other sources of funding have their benefits but also their drawbacks. Newly minted business owners should really analyze the pros and cons of each funding option and not just go with the trend,” warns Li. Crowdfunding, for example, is a great funding concept that involves the community, but Li has seen that, realistically, donor amounts rarely cover the entire cost of keeping a business running. “With multiple investors from the community, they may not understand the full extent of your business and could set difficult expectations for business owners,” Li says. He further stresses that, “If these investors take a high ownership percentage, business owners would end up having to split their profits and pay back the investors a higher amount that the interest rate on an SBA loan.”
“You can be your own boss with an SBA loan. Who wouldn’t want that?”
The U.S. Small Business Administration’s flagship 7(a) loan program guarantees up to 85 percent of SBA loans up to $150,000 and up to 75 percent on all other loans. Unsurprisingly, the reason for the financial commitment is due to the fact that small businesses represent 99.7 percent of all employer firms in the U.S. today, and generate 64 percent of new jobs and pay 44 percent of the total U.S. private payroll.
“It’s a win-win situation, since the bank’s happy and the customer’s happy with the loan,” says Li. “In the case that something were to happen and the business defaults, the majority of the loan would still be paid back by the government, which is why SBA loan advisors can reach further and give a little more through things like providing a higher down payment or a longer loan term.”
Given the access to government resources, the SBA loan’s interest rate is among the lowest in the spectrum of loans. “Let’s say a customer wants to buy a commercial building for $10 million dollars,” says Li. “A conventional loaner would normally ask for a 40 percent guaranteed down payment. The SBA loan only requires 10 percent.” Li stresses that with the extra cash flow, businesses can make better use of their money to pursue other things, such as improving inventory to push sales, or adding more value to marketing efforts.
“Another feature is when a customer asks for working capital,” says Li. “A conventional bank would usually require $500,000 in cash flow for a $1 million loan. The officer would then typically provide a three-year term with a monthly payment of $33,000 to pay off the loan.” An SBA loan, however, would ensure that for the same amount, the loan officer could provide a 10-year term that would reduce the monthly payment from $33,000 to $10,000. “And look,” says Li. “If a customer could afford to pay more than $30,000 annually using a conventional loan, that means that they could get $3 million through an SBA loan.”
Real estate lending is also more lenient through SBA loans, as “conventional loans can only give five-to-seven-year loan terms that would require refinancing after each of those terms end,” says Li. Lenders are required to reexamine the customer’s credit and analyze the existing values to assess the customer’s ability to repay the loan. “They would then charge a lot of fees,” he says. “New loan fees, appraisal fees, environmental reports, etc. I mean, who would want to deal with this every five to seven years?” With an SBA loan, the deal lasts for 25 years without any mandatory need for customers to refinance. “There’s less hassle, less paperwork and less financial stress on the business with an SBA loan,” says Li. “Even if the customer faces financial adversity over the course of 25 years, as long as they can make their monthly payments, we wouldn’t call the loan or cancel on our customers.”
Single-purpose properties such as gas stations, car washes, auto shops, healthcare facilities, etc., that are identified as high-risk properties for commercial lenders benefit tremendously from the real estate lending practices of an SBA loan.
“There are five Cs when we look into SBA loan applications,” says Li. “Those five are: cash flows, credit ratings, capacity, capital, and collateral.” A comprehensive analysis of the five Cs allows loan officers to determine whether or not their customer would receive the best value from an SBA loan.
Here’s what’s important and reassuring to know: “If you don’t think you’re going to perform very well with all of the five Cs, don’t worry,” says Li. “Credit scores, for example, are important to a certain extent, but it doesn’t dictate everything.”
What he means by this is that if a customer has a lower credit rating, the loan officer will press further to examine the level of delinquency that brought their score down. Red flags for loan officers typically include tax violations, lawsuits and bankruptcy cases, but benign cases such as missing a payment for 30 days are often looked upon with understanding.
Li understands this sentiment and is sympathetic. “As SBA loan officers, we’re here to help entrepreneurs and small businesses. We’re going to find ways to provide you with all the financial help you need, even if you aren’t confident about what you can get.”