Question: We are a medical technology and service business founded seven years ago. To date, we have serviced around 1 million patient cases and have between $2 million and $3 million in annual revenue. Despite our value to consumers, we have been turned down the three times we tried to get a working capital SBA loan for $300,000, because my wife won’t agree to put up our house as collateral. Why?
Answer: The Small Business Administration requires lenders that participate in its loan guarantee programs to secure all collateral available from principal borrowers, up to the amount of the loan. That’s a hard-and-fast rule written into the SBA lending guidelines, says Heather Endresen, senior vice president of government lending for Union Bank’s business banking group in Irvine, Calif.
“The current SBA program guidelines require the lender to require the borrower to pledge all ‘worthwhile’ collateral until the loan is fully secured on a liquidation-value basis,” she says. That includes personal assets, such as your home. If your collateral was not considered worthwhile, such as a home with less than 25 percent available equity, or if you did not have collateral, the SBA might still allow lenders to make a loan to your company on an undersecured basis if you met other qualifying criteria, such as demonstrating that you have sufficient cash flow to repay the loan.
“The SBA 7(a) loan provides a very high leverage loan, with a long-term stable amortization. For this benefit, the SBA requires borrowers to pledge other available collateral to fill any shortfall. This includes personal assets of the principals,” says George H. Harrop, managing director of small business lending at CapitalSource (CSE).
The collateral policy has been in place for many years and has minimized the overall credit loss rate of the SBA’s popular 7(a) lending program, Endresen says. “Most SBA loans are term loans of five or more years. Business assets, such as accounts receivable, inventory, and even equipment are short-term in nature, so personal real estate is often the only asset that can provide appropriate recovery value for term loans in the event of a default.”
Sometimes the willingness—or unwillingness—of a borrower to put personal assets on the line tells creditors how committed the borrower is to business success and loan repayment, says Kimberly R. Shappee, a senior credit officer at the Bank of Montana in Missoula. “If you think about it from the government’s perspective, they will come in with 75 percent of the value to make the loan good if there’s a default. If a borrower won’t put his house on the line, why would he expect all of us to put our tax dollars on the line to guarantee the loan? Banks are protecting depositors’ money—why would they risk it on someone who’s not all-in?”
In the tech and medical device industries, where company assets tend to be based on intellectual property, proprietary software, and specialized products that are difficult to liquidate, the problem is often exacerbated, Shappee says. “If your company owned commercial real estate or equipment that was easy to sell at high value,” that might serve as sufficient collateral, she says, noting that she recently approved a small business loan for a client who put up his 1968 Porsche as collateral.
Entrepreneurs in your situation are increasingly turning to more expensive forms of finance, such as accounts receivable funding. Online cash-advance company Kabbage has extended more than 100,000 advances since it was launched in May 2011, says its chief executive, Robert J. Frohwein, with “well over $150 million” in cash going to small businesses. In 2013, its total advances to small and midsize businesses have increased 133 percent over 2012, he says. Overall, alternative lending tends to be 1.5 to 5 times more expensive than SBA loans, which are pegged to today’s relatively low interest rates.
An option that might make your spouse more inclined to sign over the house is personal guarantee insurance, which was a new idea when I wrote about it in 2010. Or you could forget borrowing and instead court private investors, such as angels or venture capital firms that specialize in life sciences and biotechnology companies. Good luck.