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SBA Myths Debunked
By Chris Hurn, CEO/Cofounder, Mercantile Capital Corporation
The U.S. Small Business Administration (SBA) has garnered many criticisms and negative connotations over the years for its loan programs. Some of these may have been warranted in the past, but the SBA is very different these days and different “truths” apply to different SBA programs. Despite increased accountability and newly implemented efficiencies, there still exists a stigma (at least in some quarters) about this particular government agency.
I believe the SBA is worth every penny of its more than $824 million budget on the basis and performance of a single program alone: the SBA 504 loan program for small business owners who want to acquire or construct their own facilities. This program is especially beneficial for physicians, who have accounted for approximately 40% of my company’s fundings in the past two years. There are still numerous myths floating around that do a disservice to the SBA and to its relatively unknown 504 loan program. This article is my attempt to dispel some of the fallacies, restore some credibility to a rejuvenated and more efficient agency and spread the word about a near “secret” and little-utilized loan program that smart physicians would be wise NOT to ignore.
Not all SBA programs are the same.
Many small business owners—and far too many physicians—dismiss the SBA on the basis of its more well-known 7(a) lending program. This is the one that is most often in the news and nearly always seems to be in crisis, needing supplemental appropriations. Defenders of 7(a) loans actually took issue with the SBA when they, required this program to operate at a zero-subsidy, something 504 loans have done for over a decade. The 7(a)’s reputation may or may not be deserved, but its negative attention has managed to tarnish other effective and lesser-known SBA programs. Lumping all SBA loans into the 7(a) basket and thinking its parameters apply to all SBA programs is the most pervasive and dangerous myth that still lingers.
The SBA 504 loan program provides small business owners with 90% loan-to-cost financing for most commercial real estate projects (inclusive of land/existing building, hard construction, FF&E, plus soft and closing costs). These loans are structured with a conventional mortgage for 50% of the total project cost combined with a government-guaranteed bond for the remaining 40%. The remaining 10% is the borrower’s equity and is usually half to one-third as much as traditional lenders require, which acts to lower the business risk for physicians as opposed to lowering the lender’s risk profile with more capital injected into the real estate.
These loans are meant to finance total project costs (to conserve cash) as opposed to a percentage of the appraised value or purchase price, whichever is less, as you’ll find with most commercial lenders. The first mortgage is typically a fully-amortizing 25-year term at market rates, while the second mortgage is a 20-year term but with the interest rate fixed for the entire term at below-market rates (to improve cash-flow). For physicians, these loans with these terms provide the highest cash-on-cash return available in the commercial lending industry.
Now, let’s debunk some of the myths surrounding the SBA, shall we?
“SBA loans take too long.”
This is something I hear quite frequently. While this may have once been true, this claim is no longer valid. The SBA and the Community Development Companies (CDCs—think of them as the SBA’s representatives on these loans) are cognizant of physicians’ time and how extremely busy they are; and as such, the SBA now strives to deliver top-notch customer service. My company is able to provide firm pre-approval letters our clients can confidently stand behind within 24 hours, after receiving only seven key documents. In addition, we generally issue commitments in under a week. I know of very few ordinary lenders that move this quickly for even a conventional medical office loan.
Truth be told, the SBA examines our borrowers’ underwriting documents for an average of only 48 hours. My experience is that today’s SBA is so user-friendly that once we scan our borrowers’ documents, we actually “drag-and-drop” them onto our CDC partners’ or the SBA’s secure servers. This technological innovation saves the time of even doing overnight mail and is a huge improvement in the slow-adapting commercial mortgage industry. If an SBA loan’s approval process takes more time than this, it may be that a particular lender is holding you up, not the SBA.
“SBA loans have too much paperwork.”
This is another myth that comes up all too often. Again, this may have been the case in the past, but there have been great efforts to streamline the overall application process. My company has refined the process to nearly match the paperwork of what any ordinary, conventional commercial lender would need to approve a loan. We have actually had several borrowers comment at our closing table, “This paperwork is far less than when I refinanced my home loan.”
Some of the push for efficiency has been aided by specialist lenders who have a more refined focus in the commercial mortgage world. These specialists have made 504 loans no more complicated in terms of paperwork than ordinary commercial loans. To paraphrase an old adage and apply it to the commercial loan business: Trying to be all things to all people is frequently a recipe for disaster. Those that seek niches often find riches. (The idea of specialization is common in the medical profession, so I’m sure you can appreciate what a specialist lender might bring to the table in terms of service and efficiency.)
“SBA loans are only for the worst borrowers or for start-ups.”
This is an idea that has lasted a long time. Unlike other SBA programs, 504 loans have no revenue or employee limits and for practical purposes cap-out around $15 million for most. Nearly all of our clients are very bankable—we have clients with $50 million in revenues and some that are purely start-ups, but our typical client has $2 million to $10 million in sales. To put it another way: our primary competitors aren’t usually other SBA lenders, but rather our borrowers’ current banks, and many of them still aren’t lending these days.
The equity savings gained from SBA 504 loans are meant to provide economic development and stimulation (i.e. job retention and creation). Unhealthy companies simply cannot do this. Granted, there are some SBA programs that are for businesses still in their infancy and collateral considerations reflect that—504 loans, contrary to what some believe, are only collateralized by the property being financed, not by second mortgages on personal residences like with other SBA programs.
Overwhelmingly, 504 loans are not meant to be used by brand-new businesses who should be more concerned with using their capital to establish their place in the competitive landscape. Plain and simple, this loan program is a means of leveling the playing field for healthy medical practices contemplating commercial property ownership. Any big business with a fleet of lobbyists wouldn’t be foolish enough to ignore such a great lending program. Government data shows that nearly 98% of all businesses in Florida are eligible for a 504 financing.
“SBA loans have too many fees.”
This is another example of the “dark shadow” cast by the 7(a) program. This is the reality for the 7(a) loan’s multi-tiered fee system, but not for 504 loans. Unfortunately, this myth, too, has been unjustly applied to all programs under the agency’s umbrella. In truth, origination fees for SBA 504 loans average about 25–50 basis points higher than ordinary commercial bank loans. However, even these fees can usually be negotiated for physicians with better debt-service-coverage ratios and personal credit scores.
With the 504 loan product, these slightly higher fees seem reasonable and insignificant for most medical practitioners, since they understand that getting the highest cash-on-cash return possible (the metric by which most real estate investors measure their success) in the commercial mortgage industry is paramount. This type of financing is tailor-made for small business owners that want to decide where and when to best utilize their hard-earned capital, yet still get all the advantages property ownership provides.
“SBA loan rates are higher.”
In addition to complaints about fees, many physicians mistakenly believe this myth. This comes again from confusion among SBA programs: 7(a) loans nearly always have Prime-based floating rates whereas 504 loans nearly always have fixed rates. The effective, blended interest rates on our 504 loans are as competitive as (and in many cases, less expensive than) competing conventional bank financing.
In addition, the government-guaranteed second mortgage on 504 a loan is the least expensive money available for physicians who want to own their medical office. For most of 2010, the SBA bond rate hovered near 6% fixed for 20 years, which is an incredible deal for commercial property and awfully tough to compete against. As you can probably tell by now, the SBA 504 program provides the smartest financing available for small business owners and, as I mentioned earlier, is why the SBA is worth every penny of its budget just based on this one program alone.
“SBA loans are a government program and therefore all SBA lenders are the same.”
In reality, most credit criteria vary from lender to lender. For example, different lenders may focus on financing different property types, or they may have differing requirements for management experience or historic cash flow. It can be tempting to choose a lender based on rate (price) alone, but other factors (such as area of expertise, experience with a loan product, past performance and level of customer service) should be taken into consideration as well, just like in all buying decisions (as a medical professional, you probably don’t compete solely on the lowest common denominator—rates—either).
It’s true that the SBA of today is very different than it was even five years ago, but physicians can help themselves become more successful by carefully choosing a truly competent lender for their commercial property needs. When dealing with SBA loans, or any other loan product for that matter, the whole experience will always be made much smoother, simpler and more enjoyable for everyone involved by working with a specialist…just like in medicine.
Historically, the SBA has usually been considered a lender of last resort. But compared to ordinary commercial financing for free-standing medical office property, 504 loan terms and conditions are so good that almost every physician should select an SBA 504 loan as their top choice. Now the secret’s out: you and others now know what is honestly the savviest loan program offered by the SBA; which, by the way, shouldn’t be considered a four-letter word anymore.
