CHAPTER 18
Government Lending Programs
Federal, state, and local governments administer numerous lending programs. Many of these programs are intended to enable private capital providers to participate in riskier lending, mainly to smaller companies. These programs typically involve government lending guarantees rather than direct loans. With assurances for most of the loan principal, banks and other lending sources are enticed to participate in the loan process.
Borrowers are motivated to seek government lending programs for three reasons.
1. Most important, they cannot access the required capital without using the particular lending program. This is almost always the case with the guarantee programs of the Small Business Administration (SBA).
2. A government loan program may represent the cheapest source of capital. Industrial revenue bonds, for example, are the least expensive type of institutional capital.
3. The program may better fit their needs than other programs. This is often the case with the Certified Development Company 504 program.
Only national government lending programs are described in this chapter. Readers can contact the appropriate state and local economic resource centers for help with these programs. These loan programs are reviewed here:
- Industrial Revenue Bonds
- Business and Industry Loans, from the U.S. Department of Agriculture
- Small Business Administration Programs, such as the 7(a) loan guaranty program, the Certified Development Company 504 program, the CAPLines program, and the Export Working Capital Program
Exhibit 18.1 depicts the capital coordinates for industrial revenue bonds and the Business and Industry program.
INDUSTRIAL REVENUE BONDS
Industrial revenue bonds (IRBs) are municipal bonds whose proceeds are loaned to individuals or to businesses to finance capital investment projects. Even though they are municipal bonds, IRBs are not general obligations of the municipality. The municipality is not responsible for debt service, nor is it liable in case of default. The borrower has sole responsibility for paying the principal and interest on the bonds. Because IRBs are municipal bonds, they are exempt from federal income tax, so they have lower interest rates than most comparable capital sources. The bond proceeds are used to finance entire projects, including land, buildings and machinery, and equipment. Finally, the terms of the agreement among the municipality, the bond buyer, and the borrower are negotiated to conform to the needs of the borrower.
EXHIBIT 18.1 Capital Coordinates: Government Lending Programs
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| Capital Access Points | ||
| Capital Access Point | Industrial Revenue Bonds | Business and Industry Loans |
| Definition | Municipal bonds whose proceeds are loaned to private persons or to businesses to finance capital investment projects. | This program helps create jobs and stimulates rural economies by providing financial backing for rural businesses. This program provides federal guarantees for a loan made by a commercial lender. |
| Expected Rate of Return | 3.6% | 4.8% |
| Likely Provider | Municipalities | Banks |
| Value World(s) | Collateral value | Collateral value |
| Transfer Method(s) | Outside transfers | Outside transfers |
| Appropriate to Use When … | The lowest interest rate is sought and the project involves the acquisition of fixed assets and real estate. | A rural company needs to borrow money to create or retain jobs. |
| Key Points to Consider | Only projects with higher-paying jobs than the local area average qualify. | A minimum 10% equity is required for existing businesses and 20% for new businesses. |
Although IRBs have a variety of names and purposes, such as industrial development bonds (IDBs) and qualified small issue bonds, there are essentially three basic types. The states’ principal interest in these bonds is assisting new and expanding industry in an effort to provide residents with good jobs and wages. The regulations governing bond issuance combine federal regulations and particular statutes. The amount of IRBs each state may issue annually is based on population.
The three types of bond issuances are:
1. Tax exempt (small-issue IDBs). Because the income derived by the bondholder is not subject to federal income tax, the maximum bond amount is $10 million in any given jurisdiction. According to federal regulations, the $10 million total includes the bond amount and capital expenditures over a six-year period going both backward and forward three years. The maximum any company may have is $40 million nationwide outstanding at any given period.
2. Taxable. Taxable bonds are not exempt from federal tax. They are, however, exempt from most state taxes. The essential difference is that the taxable bond rate is more costly to the borrower, is not subject to the federal volume cap, and may exceed $10 million in bond amount.
3. Exempt facility/solid waste disposal bond. These bonds are subject to a volume cap although there is no restriction on amount, and the interest on these bonds is federally tax exempt.
All three bond types are processed and approved in the same manner. The state supervises, approves, and guides bond applications. The county bond authority issues the bonds where the facility will be located. The county authority may select bond counsel for the project. Three of the more significant regulations are:
1. Only a company engaged in some manner of manufacturing can use IRB funds. Some states also allow for pollution control facilities to qualify.
2. IRB proceeds may be used only for land, building, and equipment. Other costs that typically qualify include existing equipment, which is in place and installed as part of an integrated production line; architects’ and engineers’ fees; and issuance costs. While land can be included, it generally can comprise up to 25% of the total project cost. Specific rules govern the inclusion of the various asset classes. These rules vary from state to state, and readers should perform the necessary due diligence to ensure compliance.
3. The company must agree to pay its employees greater than or equal to the average weekly manufacturing wage of the county or the state average weekly manufacturing wage plus 10%.
In most states, IRBs can be used to finance an acquisition. For this to happen, the jobs involved must be in jeopardy because of an imminent plant closing. The acquisition must be structured as a purchase only of fixed assets and must meet the used building and equipment requirements. The bond proceeds cannot be used to refinance existing debt or as venture capital. With start-ups, the applicant must contribute an amount equal to 25% of the bond amount for beginning working capital.
For most states, it takes eight to ten weeks for an application to be approved. To handle the numerous requirements, a client should have an inducement agreement signed between his company and the county. There is neither financial nor legal liability involved with the agreement for either party. Bond counsel prepares this and other documents so the client should make an early contact. It is also appropriate to discuss the required letter of credit with a bank at the same time; it must be rated investment grade or better. The applicant negotiates the letter of credit with his bank. The bank sends the applicant a commitment letter with a copy to the local government commission. All bond issues must be supported by a letter of credit so it is important that the borrower secures a commitment early in the process.
It is the applicant's responsibility to find a buyer for the bonds. Often the bank that provides the letter of credit also places the bonds and may purchase them.
Interest rates range from a low of 40% of the prime rate to 75% of prime. The term of the loan ranges up to 30 years for real estate and up to 10 years for equipment, depending on the estimated useful life of the equipment.
Exhibit 18.2 depicts the credit box for an IRB as well as sample terms that might be offered. This credit box illustrates some of the criteria needed to gain credit access to an IRB. Each state and municipality is unique in its IRB approach. Each state is allocated a certain amount of tax-exempt bonds annually, so applicants need to make sure there is open capacity.
EXHIBIT 18.2 Industrial Revenue Bonds Credit Box and Sample Terms
| Credit Box | |
To qualify for industrial revenue bonds, an applicant must:
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| Sample Terms | |
| Example loan | $10 million loan. $2 MM land/buildings |
| $8 MM machinery and equipment (M&E) | |
| Terms | 20 years real estate |
| 7 years M&E | |
| Interest rate | 2.5% (prime rate of 3.5% less 30%) |
| Letter of credit fees | 1% per year |
| Placement fee | 1% of loan amount |
Exhibit 18.2 also shows the possible sample terms for an IRB. In this case, it is assumed that a $10 million loan is sought, with $8 million needed for machinery and equipment and $2 million needed for real estate. In the example, the machinery is financed for 7 years, while the real estate is financed over 20 years. The interest rate is the prime rate less 30%, so with prime assumed at 3.5%, the sample rate is 2.5%. The sample terms indicate the likely deal terms for an IRB. The letter of credit fee is annual and typically costs about 1% of the outstanding loan. The placement fee is charged by the placement agent and typically costs 1% to 2% of the amount raised.
The next table shows the expected rate of return to the provider of the sample terms.
The stated interest rate of 2.5% is increased by the “terms cost” of 1.1%, which yields an expected rate of return of 3.6%. The interest rate and letter of credit fees are assumed to remain the same percentages for the life of the loan. The example assumes the placement fee is financed over ten years, and only the annual return is shown.
Another government program is the Business and Industry loan program, administered by the Rural Development division of the U.S. Department of Agriculture (USDA).
BUSINESS AND INDUSTRY LOAN PROGRAM
The Business and Industry (B&I) Guaranteed Loan Program helps create jobs and stimulates rural economies by providing financial backing for rural businesses. This program provides federal guarantees for a loan made by a commercial lender.
Loan purposes must be consistent with the general purpose contained in the regulation. They include but are not limited to:
- Business and industrial acquisitions when the loan will keep the business from closing, prevent the loss of employment opportunities, or provide expanded job opportunities.
- Business conversion, enlargement, repair, modernization, or development.
- Purchase and development of land, easements, rights-of-way, buildings, or facilities.
- Purchase of equipment, leasehold improvements, machinery, supplies, or inventory.
The primary purpose is to create and maintain employment and improve the economic climate in rural communities by expanding the lending capability of private lenders in rural areas, helping them make and service quality loans.
B&I loan guarantees are extended to loans made by recognized commercial lenders or other authorized lenders in rural areas. Rural areas include all areas other than cities or unincorporated areas of more than 50,000 people and their immediately adjacent urban or urbanizing areas. Generally, recognized lenders include federal or state chartered banks, credit unions, insurance companies, savings and loan associations, farm credit banks, or other farm credit system institutions with direct lending authority.
Individual borrowers must be citizens of the United States or reside in the United States after being legally admitted for permanent residence. Corporations or other nonpublic body organization-type borrowers must be at least 51% owned by persons who are either citizens of the United States or reside in the United States after being legally admitted for permanent residence. B&I loans normally are available in rural areas, which include all areas other than cities or towns of more than 50,000 people and the contiguous and adjacent urbanized area of such cities or towns.
The total amount of agency loans to one borrower must not exceed $10 million. The administrator may, at the administrator's discretion, grant an exception to the $10 million limit for loans of $25 million under certain circumstances. For instance, the administrator may approve guaranteed loans in excess of $25 million, up to $40 million, for rural cooperative organizations that process value-added agricultural commodities. The percentage of guarantee, up to the maximum allowed, is a matter of negotiation between the lender and the agency. The maximum percentage of guarantee is 80% for loans of $5 million or less, 70% for loans between $5 and $10 million, and 60% for loans exceeding $10 million.
Maximum repayment terms are 7 years for working capital, 15 years (or useful life) for machinery and equipment, and 30 years for real estate. Collateral, which usually includes personal and/or corporate guarantees, must be sufficient to protect the interests of the lender and the government. A minimum of 10% tangible balance sheet equity is required for existing businesses and 20% for new businesses. Feasibility studies may be required. The interest rate is negotiated between the lender and borrower, and it may be fixed or variable. The lender addresses the business adequacy of equity, cash flow, collateral, history, management, and the current status of the industry in a written credit analysis. Lenders are expected to service, and if necessary, liquidate loans, with concurrence of USDA's Rural Development. There is a one-time guarantee fee equal to 2% of the guaranteed portion of the loan at the time the guarantee is issued.
Exhibit 18.3 illustrates the credit box and sample terms regarding a B&I loan.
EXHIBIT 18.3 Business and Industry Loan Guaranty Program Credit Box and Sample Terms
| Credit Box | |
To qualify for a B&I loan, an applicant must:
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|
| Sample Terms | |
| Example loan | $5 million loan. $2 MM land/buildings |
| $3 MM M&E | |
| Terms | 20 years real estate |
| 7 years M&E | |
| Interest rate | 4.5% (prime rate of 3.5% + 1%) |
| Bank closing fee | 1% of loan amount |
| Guaranty fee | 2% of guaranty portion |
In this case, it is assumed a $5 million loan is sought, with $3 million needed for machinery and equipment and $2 million needed for real estate. The machinery is financed for 7 years while the real estate is financed over 20 years. The interest rate is prime + 1%, with prime assumed at 3.5%. Thus, the example uses 4.5% as the interest rate.
The next table shows the expected return of a B&I loan.
The stated interest rate of 4.5% is increased by the “terms cost” of .3%, which yields an expected rate of return of 4.8%. The bank closing fee and guaranty fee are treated as if they are financed over ten years. The guaranty fee is actually paid to the USDA for supplying the guarantee. This fee adds to the return expectation of the deal but not to the bank's return. It is assumed the bank would not make the loan at the stated interest rate, or perhaps not at all, without the government guarantee.
SMALL BUSINESS ADMINISTRATION PROGRAMS
The U.S. Small Business Administration, established in 1953, provides financial, technical, and management assistance to help Americans start, run, and grow their businesses. With a portfolio of business loans, loan guarantees, and disaster loans worth more than $80 billion, the SBA is the nation's largest single financial backer of small businesses.
The SBA enables its lending partners to provide financing to small businesses when funding is otherwise unavailable on reasonable terms. It guarantees major portions of loans made to small businesses. The SBA does not currently have funding for direct loans nor does it provide grants or low-interest-rate loans for business start-up or expansion.
The eligibility requirements and credit criteria of the program are very broad in order to accommodate a wide range of financing needs. When a small business applies to a lending partner for a loan, the lender reviews the application and decides if it merits a loan on its own or if it requires an SBA guaranty. The lender then requests SBA backing on the loan. By guaranteeing the loan, the SBA assures the lender that the government will reimburse it for a portion of its loss, in the event the borrower does not repay the loan.
By providing this guaranty, the SBA enables tens of thousands of small businesses to get financing every year that they would not otherwise obtain. To qualify for an SBA guaranty, a small business must meet SBA criteria, and the lender must certify that it could not provide funding on reasonable terms without an SBA guaranty.
Exhibit 18.4 shows the capital coordinates for the 7(a) and 504 SBA loan programs.
EXHIBIT 18.4 Capital Coordinates: SBA 7(a) and SBA 504 Programs
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| Capital Access Points | ||
| Capital Access Point | SBA 7(a) | SBA 504 |
| Definition | Provides loan guarantees to small businesses unable to secure financing on reasonable terms through normal lending channels | Provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings |
| Expected rate of return | 5.8% | 4.0% |
| Likely provider | Banks | Banks, certified development companies |
| Value world(s) | Collateral value | Collateral value |
| Transfer method(s) | All but public | All but public |
| Appropriate to use when … | A loan guaranty is the only way to obtain the required financing | A borrower wants to minimize the equity investment |
| Key points to consider | Personal guarantees required of borrower and spouse; the SBA sets maximum interest rates | Personal guarantees required; low blended interest rates |
The SBA administers more than a dozen programs. This chapter focuses on four of them: the 7(a) Loan Guaranty Program, the Certified Development Company (504) loan program, the CAPLines loan program, and the Export Working Capital program.
7(a) LOAN GUARANTY PROGRAM
The 7(a) Loan Guaranty Program, SBA's primary lending program, provides loan guarantees to small businesses unable to secure financing on reasonable terms. It operates through private-sector lenders that provide loans, which are in turn, guaranteed by the SBA.
Information on SBA loan programs is available on the Internet at www.sba.gov as well as through the management counseling and training services offered by the agency available from local SBA offices.
As of this writing, this SBA program can guarantee as much as 85% on loans of up to $150,000 and 75% on loans of more than $150,000. 7(a) loans have a maximum loan amount of $2 million. SBA's maximum exposure is $1.5 million. Thus, if a business receives an SBA-guaranteed loan for $2 million, the maximum guaranty to the lender will be $1.5 million, or 75%. The ability of the business to repay the loan from cash flow is a primary consideration in the SBA loan decision process; however, good character, management capability, collateral, and owner's equity contribution are also important considerations. All owners with a 20% or greater interest are required to personally guarantee SBA loans.
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 three factors: business type, business size, and use of the loan.
Business Type
Most businesses are eligible for SBA assistance. An applicant business must operate for profit; be engaged in, or propose to do business in, the United States or its possessions; have reasonable owner equity to invest; and use alternative financial resources first, which includes personal assets. Ineligible businesses include real estate investment and other speculative activities; lending activities; pyramid sales plans; illegal activities; gambling activities; and charitable, religious, or certain other nonprofit institutions.
Size of Eligible Businesses
The Small Business Act defines an eligible small business as one that is independently owned and not dominant in its field of operation. In determining what a small business is, the definition shall vary from industry to industry to reflect market differences. Most businesses are eligible under the act; however, potential borrowers should check the SBA Web site for exact size eligibility descriptions.
Use of Proceeds
The proceeds of SBA loans can be used for most business purposes. These may include the purchase of real estate to house the business operations; construction, renovation or leasehold improvements; acquisition of furniture, fixtures, machinery, and equipment; purchase of inventory; and working capital.
Proceeds of an SBA loan cannot be used to:
- Finance floor plan needs.
- Purchase real estate where the participant has issued a forward commitment to the builder/developer, or where the real estate will be held primarily for investment purposes.
- Make payments to owners or pay delinquent withholding taxes.
- Pay existing debt unless it can be shown that the refinancing will benefit the small business and that the need to refinance is not indicative of imprudent management. (Proceeds can never be used to reduce the exposure of the participant in the loans being refinanced.)
SBA loan programs generally are intended to encourage longer-term small business financing. Actual loan maturities are based on the ability to repay, the purpose of the loan proceeds, and the useful life of the assets financed. However, maximum loan maturities have been established: 25 years for real estate and equipment and, generally, 7 years for working capital.
Interest rates are negotiated between the borrower and the lender but are subject to SBA maximums, which are pegged to the prime rate, LIBOR (London Interbank Offered Rate), or an optional peg rate. Interest rates may be fixed or variable. These are the interest rates for fixed-rate loans:
- Fixed-rate loans of $50,000 or more must not exceed the base rate plus 2.25% if the maturity is less than seven years and the base rate plus 2.75% if the maturity is seven years or more.
- For loans between $25,000 and $50,000, maximum rates must not exceed the base rate plus 3.25% if the maturity is less than seven years and the base rate plus 3.75% if the maturity is seven years or more.
- For loans of $25,000 or less, the maximum interest rate must not exceed the base rate plus 4.25% if the maturity is less than seven years and the base rate plus 4.75% if the maturity is seven years or more.
Variable-rate loans may be pegged to the lowest prime rate, LIBOR, or the SBA optional peg rate. The optional peg rate is a weighted average of rates the federal government pays for loans with maturities similar to the average SBA loan. It is calculated quarterly and published in the Federal Register. The lender and the borrower negotiate the amount of the spread, which will be added to the base rate. An adjustment period is selected that will identify the frequency at which the note rate will change. It must not be more often than monthly, and it must be consistent (e.g., monthly, quarterly, semiannually, annually, or any other defined period).
To offset the taxpayer costs of SBA's loan programs, the agency charges lenders a guaranty and a servicing fee for each loan approved. These fees can be passed on to the borrower once the lender has paid them. The amounts of the fees are determined by the amount of the loan guaranty. For loans more than $150,000 but up to and including $700,000, a 3% guaranty fee will be charged. For loans greater than $700,000, a 3.5% guaranty fee will be charged. In addition, all loans will be subject to a 50 basis point (0.5%) annualized servicing fee, which is applied to the outstanding balance of SBA's guaranteed portion of the loan.
Processing fees, origination fees, application fees, points, brokerage fees, bonus points, and other fees that could be charged to an SBA loan applicant are prohibited. A commitment fee may be charged only for a loan made under the Export Working Capital Loan Program.
Prepayment
There is a prepayment penalty for those loans that meet the next criteria:
- Have a maturity of 15 years or more where the borrower is prepaying voluntarily.
- The prepayment amount exceeds 25% of the outstanding balance of the loan.
- The prepayment is made within the first three years after the date of the first disbursement (not approval) of the loan proceeds.
The prepayment fee calculation is:
- During the first year after disbursement, 5% of the amount of the prepayment.
- During the second year after disbursement, 3% of the amount of the prepayment.
- During the third year after disbursement, 1% of the amount of the prepayment.
Exhibit 18.5 shows the credit box and sample terms for the 7(a) program. The sample terms assumes a $2 million loan is sought, with $1 million needed for machinery and equipment and $1 million needed for real estate. Machinery is financed for 7 years while the real estate is financed over 20 years. The interest rate is prime plus 1.5%, with prime assumed at 3.5%. Thus, the example uses 5% as the interest rate.
EXHIBIT 18.5 SBA 7(a) Loan Guaranty Program Credit Box and Sample Terms
| Credit Box | |
To qualify for an SBA loan guaranty, an applicant must:
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| Sample Terms | |
| Example loan | $2 million loan. $1 MM land/buildings |
| $1 MM M&E | |
| Terms | 20 years real estate |
| 7 years M&E | |
| Interest rate | 5% (prime rate of 3.5% + 1.5%) |
| Bank closing fee | 1% of loan amount |
| Guaranty fee | 3.5% of guaranty portion |
| Servicing fee | .5% annual service fee |
The next table computes the expected rate of return to the provider based on the sample terms.
The stated interest rate of 5% is increased by the “terms cost” of .8%, which yields an expected rate of return of 5.8%. The bank closing fee and guaranty fee are amortized over 10 years.
CERTIFIED DEVELOPMENT COMPANY 504 LOAN PROGRAM
The 504 Certified Development Company (CDC) Program provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings. A CDC is a nonprofit corporation set up to contribute to the economic development of its community. CDCs work with the SBA and private-sector lenders to provide financing to small businesses. Each of the 250 or so CDCs nationwide covers a specific geographic area.
Typically, a 504 project includes a loan secured with a senior lien from a private-sector lender covering up to 50% of the project cost, a loan secured with a junior lien from the CDC (backed by a 100% SBA-guaranteed debenture) covering up to 40% of the cost, and a contribution of at least 10% equity from the small business being helped.
In order to qualify for the program, the borrower must meet the SBA's definition of “small business” and must plan to use over half (51%) of the property for its own operations within one year of ownership; if the building is to be newly constructed, the borrower must use 60% at once and plan to occupy 80%. The borrower may form a real estate holding company that lease 100% to the operating business, which then subleases surplus space (up to 49%). To qualify for this program, U.S. citizens or permanent residents must hold a majority of the ownership of the operating companies and the holding company. There are three criteria for eligibility:
1. The company's average net income cannot surpass $2.5 million after taxes for the preceding two years.
2. The anticipated project size must be greater than the personal, nonretirement, unencumbered liquid assets of the guarantors/principles.
3. The company does not have a tangible net worth in excess of $7.5 million.
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.
The maximum SBA debenture is $1.5 million when meeting the job creation criteria or a community development goal. Generally, a business must create or retain one job for every $65,000 provided by the SBA except for small manufacturers, which have a $100,000 job creation or retention goal.
The maximum SBA debenture is $2.0 million when meeting a public policy goal. These include:
- Business district revitalization
- Expansion of exports
- Expansion of minority business development
- Rural development
- Increasing productivity and competitiveness
- Restructuring because of federally mandated standards or policies
- Changes necessitated by federal budget cutbacks
- Expansion of small business concerns owned and controlled by veterans (especially service-disabled veterans)
- Expansion of small business concerns owned and controlled by women
The maximum debenture for small manufacturers is $4.0 million. A “small manufacturer” is defined as a company that has its primary business classified in sector 31, 32, or 33 of the North American Industrial Classification System (NAICS) and all of its production facilities located in the United States. To qualify for a $4.0 million 504 loan, the business must meet the definition of a small manufacturer and either (a) create or retain at least one job per $100,000 guaranteed by the SBA or (b) improve the economy of the locality or achieve one or more public policy goals.
Interest rates on 504 loans are pegged to an increment above the current market rate for 5- and 10-year U.S. Treasury issues. Maturities of 10 and 20 years are available. Fees total approximately 3% of the debenture and may be financed with the loan. Generally, the project assets being financed are used as collateral. Personal guarantees 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 $6 million and does not have an average net income in excess of $2 million after taxes for the preceding two years. Loans cannot be made to businesses engaged in speculation or investment in rental real estate.
Exhibit 18.6 shows the credit box and sample terms for the SBA 504 program.
EXHIBIT 18.6 SBA 504 Loan Program Credit Box and Sample Terms
| Credit Box | |
To qualify for a 504 loan, an applicant must:
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|
| Sample Terms | |
| Example loan | $2 million project. $1 MM land/buildings |
| $1 MM M&E | |
| Terms | 20 years real estate |
| 7 years M&E | |
| Interest rate | 3.8% (prime rate of 3.5%, blended) |
| Bank closing fee | 1% of loan amount |
| Debenture fee | 3% of debenture amount |
This example assumes a $2 million project, with $1 million needed for machinery and equipment and $1 million for real estate. The machinery is financed for 7 years while the real estate is financed over 20 years. The interest rate is prime plus 1% for the bank part of the loan and prime minus .5% for the SBA debenture, with prime assumed at 3.5%. Thus, the example will use 4.5% as the interest rate for the bank portion and 3% for the debenture. On a weighted average basis, the blended rate is as shown in the next table.
For a 504 loan of $1.8 million, the bank loans $1 million, the SBA offers a debenture of $800,000, and the borrower contributes $200,000 in equity. The blended interest rate between the bank and debenture rates is 3.8%. A computation of the expected rate of return to the provider based on the sample terms is shown next.
The blended interest rate of 3.8% is increased by the “terms cost” of .2%, which yields an expected rate of return of 4.0%. The bank closing fee and debenture fee are amortized over ten years.
CAPLINES LOAN PROGRAM
CAPLines is the umbrella program under which the SBA helps small businesses meet short-term and cyclical working capital needs. A CAPLines loan can be for any dollar amount, except for the small asset-based line. There are five short-term working-capital loan programs for small businesses under the CAPLines umbrella:
1. Seasonal line. Advances against anticipated inventory and accounts receivable help during peak seasons when businesses experience seasonal sales fluctuations. Can be revolving or nonrevolving.
2. Contract line. Finances the direct labor and material cost associated with performing assignable contract(s). Can be revolving or nonrevolving.
3. Builders’ line. Used by small general contractors to 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. 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. 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, providing the business can consistently show repayment ability from cash flow for the full amount.
Except the small asset-based line, CAPLine loans follow SBA's maximum loan amounts. Thus, SBA can guarantee as much as 85% on loans of up to $150,000 and 75% on loans of more than $150,000. 7(a) loans have a maximum loan amount of $2 million. SBA's maximum exposure is $1.5 million. Thus, if a business receives an SBA-guaranteed loan for $2 million, the maximum guaranty to the lender will be $1.5 million, or 75%. Eligibility for this program is the same as for the SBA 7(a) guaranty loan program, discussed earlier in this chapter.
Each of the five lines of credit has a maturity of up to five years. A shorter initial maturity may be established to suit individual business needs. 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.
Exhibit 18.7 displays the capital coordinates for the CAPLines and Export Working Capital programs.
Interest rates, guaranty amounts, and fees are the same for CAPLine loans as with the 7(a) loan program mentioned earlier. Exhibit 18.8 contains the credit box and sample terms for the CAPLines program.
In this example, it is assumed a $1 million loan is sought. The interest rate is prime plus 2%, with prime assumed at 3.5%. Thus, the example uses 5.5% as the interest rate. The next table computes the expected rate of return to the provider of the sample terms.
The stated interest rate of 5.5% is increased by the “terms cost” of 1.2%, which yields an expected rate of return of 6.7%. The bank closing fee and guaranty fee are amortized over five years.
EXHIBIT 18.7 Capital Coordinates: SBA CAPLines and SBA EWCP Programs
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| Capital Access Point | SBA CAPLines | SBA EWCP |
| Definition | The umbrella program under which the SBA helps small businesses meet their short-term and cyclical working capital needs | The SBA's Export Working Capital Program (EWCP) is designed to provide short-term working capital to exporters |
| Expected rate of return | 6.7% | 9.7% |
| Likely provider | Banks | Export-import bank |
| Value world(s) | Collateral value | Collateral value |
| Transfer method(s) | Not suitable for transfers | Not suitable for transfers |
| Appropriate to use when … | 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 | The EWCP supports export financing to small businesses when that financing is not otherwise available on reasonable terms |
| Key points to consider | The maximum amount the SBA can guaranty is generally $750,000, which limits the CAPLine to $1 million | The program encourages lenders to offer export working capital loans by guaranteeing repayment of up to $1 million, or 90% of a loan amount, whichever is less |
EXHIBIT 18.8 CAPLines Loan Program Credit Box and Sample Terms
| Credit Box | |
To qualify for a CAPLines loan, an applicant must:
|
|
| Sample Terms | |
| Example loan | $1 million |
| Terms | 5-year maturity |
| Interest rate | 5.5% (prime rate of 3.5% + 2%) |
| Bank closing fee | 1% of loan amount |
| Guaranty fee | 3.5% of debenture amount |
| Servicing fee | .5% per year |
EXPORT WORKING CAPITAL PROGRAM
The SBA's Export Working Capital Program (EWCP) provides 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 90% of a loan amount, or $750,000, whichever is less. A loan can support a single transaction or multiple sales on a revolving basis.
EWCP loans are used for transaction financing. For example, an EWCP loan will support 100% of supplier costs for an export transaction. EWCP loans can also be used to even out cash flow when exporters have negotiated longer sales terms and cannot carry the resulting receivables with their own working capital. The EWCP loan can be a short-term loan for a single contract or in the form of a line of credit that supports ongoing export sales for a period of 12 months.
Eligible transactions include:
- The exports being financed must be shipped and titled from the United States; there is no U.S. content requirement for the product being exported.
- The exports must comply with all U.S. Export Administration Regulations and cannot be shipped to a country where the United States has imposed trade embargos or sanctions.
- “Indirect” exports to domestic buyers who subsequently export qualify for EWCP financing.
Financing is available for manufacturers, wholesalers, export trading companies, and service exporters. EWCP loan borrowers must meet SBA 7(a) eligibility and size standards (less than 500 employees for manufacturers, less than 100 employees for wholesalers) and have been in business for at least one year. SBA can waive the one-year-in-business requirement if the applicant can demonstrate sufficient export expertise and business experience.
The maximum EWCP line of credit/loan amount is $2 million. Participating banks receive a 90% SBA guaranty provided that the total SBA-guaranteed portion to the borrower does not exceed $1.5 million. In those instances where the SBA-guaranteed portion reaches the $1.5 million cap, banks can still get a 90% guaranty thanks to a coguaranty program between SBA and the Export-Import (EXIM) Bank of the United States. Under this program, the bank still submits only one loan application to the SBA and receives a 90% U.S. government guaranty that is backed by both agencies. For the EXIM Bank guaranteed portion, a higher fee may apply.
EWCP loans are typically issued for one year. The SBA does not establish or subsidize interest rates on loans. The interest rate can be fixed or variable and is negotiated between the borrower and the participant lender.
The SBA fee for an EWCP loan with a 12-month maturity or less is ¼ percent (0.25 percent) assessed on the guaranteed portion of the loan. For example, for a one-year $1 million line of credit with a 90% guaranty ($900,000 guaranteed portion), the guaranty fee is $2,250 ($900,000 × 0.25 percent). The SBA can reissue EWCP loans on an annual basis, and the guaranty fee remains ¼ percent.
The export-related inventory and the receivable generated by the export sales financed with EWCP funds will be considered adequate collateral. The SBA also requires the personal guarantee of owners with 20% or more ownership.
Exhibit 18.9 shows the credit box and sample terms for this program.
EXHIBIT 18.9 EWCP Credit Box and Sample Terms
| Credit Box | |
To qualify for an SBA Export Working Capital Loan Guaranty, an applicant must:
|
|
| Sample Terms | |
| Example loan | $1 million |
| Terms | 1-year maturity |
| Interest rate | 5.5% (prime rate of 3.5% + 2%) |
| Bank closing fee | 1% of loan amount |
| Guaranty fee | 3% of guarantee portion |
| Servicing fee | 1% annual service fee |
In this example, it is assumed a $1 million loan is sought and the interest rate is prime plus 2%, with prime assumed at 3.5%. Thus, the example uses 5.5% as the interest rate. The next table computes the expected rate of return to the provider of the sample terms.
The stated interest rate of 5.5% is increased by the “terms cost” of 4.2%, which yields an expected rate of return of 9.7%. Since this example assumes a one-year term for the loan, the bank closing fee and guaranty fee are paid at the closing.
NEGOTIATING POINTS
Most of the negotiating points regarding government lending programs occur at the underlying bank level. For instance, nearly all of the negotiating points mentioned in Chapter 17 can be applied to the bank portion of the government programs. Since the governmental part of the programs generally follows bureaucratic rules, it is unlikely to be negotiated.
Other Government Programs
There exist other government lending and investment programs than the ones mentioned earlier. Many of these are local or state sponsored. These can be found by reviewing local and state Internet sites.
Exhibit 18.10 summarizes the stated interest rates and expected returns for the programs presented in this chapter.
EXHIBIT 18.10 Summary of Interest Rates by Government Lending Program
| Stated Rate | Expected Return | |
| IRBs | 2.5% | 3.6% |
| B&I loans | 4.5% | 4.8% |
| 7(a) loans | 5.0% | 5.8% |
| 504 loans | 3.8% | 4.0% |
| CAPLines | 5.5% | 6.7% |
| EWCP | 5.5% | 9.7% |
TRIANGULATION
Government lending programs position government as an active player in the private capital markets. The government's intentions are market oriented, and they are designed to improve capital access for companies that otherwise might not be able to fund their business plans. This contrasts with the role of government in valuation, where its interests are tax/revenue based. In other words, government intentions regarding valuation issues are directed outside of the market and may or may not reflect market reality.
Access to capital affects the value of a firm. Government lending programs dramatically improve capital access. In some cases, such as IRBs, the borrower substantially reduces its cost of capital by implementing a government loan program. In most cases, such as the SBA programs, the borrower reduces its cost of capital but, more important, increases its capital base to provide for future growth.
Government lending programs help fledgling companies grow into middle-market companies. This is no small feat. Desperately needed capital is the most difficult to arrange. Small companies have a difficult time attracting capital for this reason. Joe Mainstreet likely started out in business by securing a bank loan with an SBA guarantee. Once a company grows beyond $10 million to $20 million in revenues, its options increase relative to funding alternatives.
Most of the government programs mentioned in this chapter support business transfer needs. In some cases, the government program seals the deal. Recently, a buyer group became so enamored with the seller's low rate on an IRB that it upped its bid dramatically so the building and IRB would be included in the deal.
Two SBA programs, the 7(a) and 504, are especially useful in supporting business transfers. A large percentage of small business transfers would not be possible without these government programs. Although it is not the purpose of this book to extol the virtues of the SBA, this agency became much more user-friendly in the 1990s and now is highly responsive to its constituents’ needs.