Another alternative for you to consider in funding your business is the recent push by the Obama administration on SBA lending. I had some firsthand experience recently securing a $250K loan for one of the companies I’m working with, and I thought it might be useful to describe the process and what to expect.
What is an SBA Loan? It’s a loan provided by a major bank to grow your business which is quaranteed by the US Government under the Small Business Administration lending program. Here is a good link describing it:
http://usgovinfo.about.com/od/smallbusiness/a/sbaloans.htm
It is a loan that you, as the entrepreneur/founder, have to personally guarantee with your personal assets. That could be equity in your house, savings or other personal assets. If the venture fails, you are on the hook to pay it back, so only do this if your financial situation permits and you understand the risks.
The nice thing about this sort of financing is that it is non-dilutive, no equity is given in return. However, like all capital raising, it involves a lot of paperwork, perhaps even more so as a government program.
Although we had no idea what the process entailed, we suspected it was rather involved and thought seriously about why we’d put ourselves through the ringer doing all the paperwork when at the end of the day we’d be personally guaranteeing the loan anyway. Why not instead just draw upon a home equity line of credit?
Well, this is a cleaner way to do it – it’s a loan to the company and the interest is tax deductible while the HELOC’s interest is only deductible at the personal level up to $100K of principal. It also forces some discipline in financial planning, reporting and cleaning up elements of the company that you may not have tackled so far and would usually come up when raising your first institutional funding round.
Here is what we went through:
April:
- Contacted 3 local banks (Bridge Bank, Wells Fargo and First Republic) to inquire about their SBA programs. Only Wells Fargo could do this program and it turns out they are the largest in Silicon Valley doing it. Bridge Bank considered doing an accounts receivable (AR) factoring line, but this was quite limited given the early life of the company and First Republic considered a much smaller line of credit, also due to the early stage of the company.
- The ideal structure would have been a line of credit (draw as needed / pay interest only when needed). Wells Fargo could only do a term loan with a short draw period. Not ideal but something we could live with. So we went ahead with them.
May:
- Filled out the SBA loan application form, gathered supporting documentation. This took about a week to do.
- Submitted 3 years personal tax returns including all K1s. Also: retirement savings balances, checking/savings account balances, home equity line, mortgage and home value information.
- Submitted historical actual and detailed financial projections for the company’s revenue, operating costs, hiring plans, cash, AR etc. This detailed model took about another week to pull together but was a useful exercise.
- Wells Fargo provided critical review of financial projections and suggested some items that were missing or may have been optimistic. This was actually quite helpful.
June:
- Back and forth on financial projections and size of loan. $100K seemed all they could do based on the assets of the business, it’s 1 year operating history (even with strong cash flow) and a 3 months maximum drawdown period. It was quite disappointing to arrive at this after two months of working it.
- 6% interest rate, not bad but certainly not as good as our HELOC which is running around 4%.
July:
- Resubmitted financial statements for June including accounts receivable.
- It turned out that the business had a surge in revenue in June/July and a corresponding larger accounts receivable, which ended up being a key factor in getting approval for a larger $250K loan versus a $100K. Our Wells Fargo rep also succeeded in getting the underwriter to approve a 6 month draw period, much better. They came through nicely here!
- Paid $2,200 fee deposit, which goes about half to Wells Fargo and half to the Government. In the end, the fee ended up being less at about $1600 and we got a refund. The Obama administration is waiving most of the usual $4,000 SBA fee, so this is a decent incentive.
- Submitted fully executed Operating Agreement, filed Articles of Organization, sorted through a 1″ thick stack of SBA forms – #159, 1624, 4, 413 and 912.
August:
- In preparation for adding people, the startup secured new office space and signed a lease. That triggered another round of paperwork – submit the new lease, get the landlord to sign a Landlord Waiver Form and add lender as an Assignee on the lease. Also, we needed to put in place a business hazard insurance policy with Wells Fargo as a loss payee. Fortunately this could be done quickly with a local agent at State Farm, Manny Casillas, who our realtor, Samia Morgan, recommended. Samia was awesome at helping get the office, touring some 30+ properties! Manny was also terrific.
- There were complications/delays, related to things like business registrations, leases, ownership structure, and flood plain insurance (don’t ask). You have to have all of your ducks lined up in a row, and it’s hard to do this while actually running and growing your company, as things change almost daily.
So 5 months from start to end, longer than the time it would typically take for a VC or angel investor to do diligence.
It’s a risky way to bootstrap your business and certainly not as ideal as a revolving line of credit, but as a new startup it may be the only source of debt financing out there. While the amount of the loan is limited by what appears to be the amount of AR or equipment assets, it can provide a useful way to finance a few months of growth until enough time goes by that AR based lending can kick in at larger amounts or it would make more sense to raise a venture capital or angel round.
If you would like more information from our Wells Fargo contact, get in touch with Rick Shade or Chad Barbieri, I’d highly recommend them - Rick.Shade at wellsfargo dot com or Chad.Barbieri at wellsfargo dot com
Thanks for this excellent info. I have often wondered about the SBA loan details. You are truly providing value to the startup community with your blog posts.
Thanks Dadi! It was a lot of work to get this in place but it was the right type of funding needed for the business. It’s important to make that distinction. Often, entrepreneurs go down a path with venture and angel investment when that is not really what they need. Here it was clearly a cash flow timing issue that needed to be solved.
We’ll be happy to consider this company’s later funding needs, if they for example are doing extensive product development with high risk and venture funding might be more appropriate.
I also found the folks at Wells Fargo to be great to work with. Despite the amount of time it took and complexity of paperwork, it was a good opportunity to clean house and be truly ready should the need for venture funding arise.