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Update: Analyzing the SBA Lending Market

Markets are balancing from the risk model to the opportunity model for lenders.

There are many moving parts to the U.S. Small Business Administration lending universe, and many changes have been implemented to help ease access to small-business lending.  Two of these will be addressed in more detail later in this article, the Small Loan Advantage and major changes to the Statement of Personal History “Form 912.”  First, let’s take a look at the market for franchise SBA lending and where it is working and not working.

Lending for existing franchisees looking to expand is very functional, with lenders competing for great borrowers in great brands.  Of course, this is limited to the excellent operators who show verifiable cash flow on their tax returns.  Some dysfunction still exists when franchisor development schedules are too aggressive, and lenders do not understand multi-unit strategies when mapping out a long-term plan for their borrowers.

Franchisors and franchisees need to do a better job in educating lenders on why multi-unit growth is imperative to the long-term success of the franchisee, and that it is very manageable for a franchisee to operate multiple units in a short ramp-up period.  Of course, the franchise disclosure document does not offer the ability for this disclosure, but products like FRANdata’s Bank Credit Report or a confidential lender addendum can offer lenders guidance on these and other issues that are not in the FDD.

First-time franchisees with no operating history are still seeing many obstacles to gaining financing for the first unit in many brands; however, brands with a stellar performance history are seeing banks calling on them once again for borrowers.  This is a sign that the markets are balancing from the risk model to the opportunity model for lenders.

Smaller brands and smaller loan sizes still offer a challenge for borrowers and lenders.  Emerging brands with little or no performance history need to step up and disclose more to lenders, or offer enhancements to get predictable funding.  Brands with lower investment amounts, under $250,000, do not offer lenders enough of a loan size that makes it profitable for lenders to offer financing.  The SLA program may be a silver bullet for these smaller loans, but more on that later.

We have not seen a return to the “go” times when loans were so plentiful that any operator with a decent credit score could get a loan.  We should all hope that we never go back to those days so we do not have to experience another meltdown in the credit markets.

Small Loan Advantage (SLA)

In 2012, the SBA recognized that many lenders were reluctant to participate in the agency’s program with respect to smaller loans – those under $350,000.  SBA’s mission is to expand access to capital for small businesses and entrepreneurs in underserved communities so that it can help drive economic growth and job creation.  The need to encourage lenders to provide an increased number of lower-dollar loans to small business became evident.

As a result, in the spring of 2012, SBA rolled out the Small Loan Advantage Program to allow lenders to be able to use a scoring system together with expedited processing to issue smaller loans while still enjoying a 75 percent guaranty from the United States (85 percent where the loans are $150,000 or less).  While initially rolling out the SLA program for Preferred SBA lenders in June, SBA made the SLA program available to most lenders who participate in SBA lending.

Here are four advantages of the SLA program for lenders:

  1. Lender can score the deal with the SBA so that its underwriting decision cannot be “second guessed” later;
  2. Lender is not required to take all available collateral;
  3. Expedited underwriting times by letting the lender use a scoring model; and
  4. Expedited closing times by letting the lender use the closing documents and procedures similar to the SBA’s Express program.

Because this is a new program, not all lenders have adopted it and those that have adopted it have not exercised its full flexibility in crafting a separate set of credit guidelines for smaller business loans using a scoring model.  However, as the SLA program usage grows, franchisees will be able to enjoy the benefits of expedited processing, lower costs and, in some cases, less collateral impact.

Things are brighter this year than in the past five years, but credit departments in banks still have veto power on transactions.

Another benefit of the SLA loan is that it is counted against the individual borrower limit of $5 million, so multiple SLA loans can be used to help grow a franchisee’s enterprise in smaller-unit investment concepts.

Helpful Changes to SBA’s 912 Form

It should be no surprise that good character and credibility are essential for any loan application. As a practical matter, government-backed loans from SBA require additional due diligence on applicants who have been arrested or charged with a criminal offense.

The completion of an SBA Form 912, also known as the Statement of Personal History or “912,” by each subject individual is part of the character determination process. SBA requires that every individual who is subject to the 912 requirements (proprietor, general partner, officer, director, owner holding 20 percent or more, and any person who manages the day-to-day operations of the business) be of good character.

Every subject individual is required to complete the form, which includes information regarding any past or present arrest, indictment, conviction, probation or other adjudication for any criminal offenses other than minor motor vehicle violations.

In the event there is a past offense, the individual must undergo a background check and provide additional information, which normally delays the approval process.  However, a borrower-friendly revision to the form refers to offenses in the past six months. In effect, an individual who was arrested 20 years ago for a misdemeanor should not be subject to SBA’s background check. This should allow creditworthy small-business borrowers to qualify for SBA lending without significant processing delays.

Rule Changes Proposed

Some proposed rule changes that would be beneficial are in discussion at the SBA.  The most important of those would be the proposed elimination of the “Personal Resources Test” that disqualifies SBA financing for people who have too much liquidity as defined by SBA rules.  This disallows qualified borrowers from raising equity from investors who are helping them to start and expand businesses.  Elimination of the test would make this possible and encourage qualified operators to expand and grow while taking advantage of SBA’s higher $5 million limits.

Things are brighter this year than in the past five years.  However, the credit departments in banks still have veto power on transactions and will maintain that power for the foreseeable future.  That said, SBA lending is a great option for franchisees starting or expanding their businesses with limited real collateral or experience.  Franchisors must participate in the credit access process and utilize the Bank Credit Report, SBA Registry and other tools to assist franchisees in gaining access to capital.

Nate Greenberg, CFE, is a principal of Siegel Financial Group.  He can be reached at 610-668-9780 or ngreenberg@siegelfg.com.

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