For most businesses there are a couple of ways to raise capital. One is by offering equity, the other is receiving loan.
Offering equity is giving an investor a share of the future profits of the organization in exchange for that investor providing capital. An example of this would be the stock market. Start-up companies often give equity to investors because their capital needs can exceed the amount of money they could reasonably hope to borrow. Equity can be structured many ways from buying stock, to a friend buying into another’s business.
The benefit of offering equity is that if the business fails the investors lose their money and there is no remaining obligation. The downside of offering equity is that if the business succeeds then the money paid to investors will eventually far exceed the amount paid for a similar amount of capital from a borrowed lender.
Most small to medium sized businesses that seek capital try to get a loan from a bank as opposed to offering equity in their company. However, the downside of getting a loan is that the bank expects/demands to get its money back. It will be a problem for someone if the business does not generate the cash to pay back the loan.
Since a bank’s profit on a loan is limited to the interest paid and their potential loss can be up to the amount owed, they have to be very careful when making a loan. As a result, most banks will look for at least two ways for the borrower to repay his loan.
Having more than one way to repay the money that a company is seeking is one of the main differences between being able to be a borrower or having to offer equity instead.
One of the first questions that a bank will ask a borrower is, ‘How are you going to pay the bank back if your business does not succeed as well as you would like it to.’ If a borrower wants to get a loan there needs to be a good answer to that question. If this question can’t be reasonably answered then instead of looking for a loan one should be looking for investors.
Often times some sort of collateral is used as the secondary source of repayment. For banks that make real estate loans, it is the property that serves the secondary source of repayment. For this reason banks try to limit the loan-to-value it provides on a transaction to a level that will allow it to recover loan funds in the event of a default.
The other thing that banks look for when deciding to make a loan is how much the borrower’s own funds will be put into the transaction. The unofficial term for this is “skin in the game.” A bank wants to know that the borrower has something to lose if there is a problem with the loan.
Having the ability to put your own funds into a transaction is something banks look for in a borrower. Without some skin in the game, you would be looking for equity.
Cash flow – I discussed cash flow in a previous e-mail. Suffice to say a borrower will have to show the ability to pay back a loan based upon tax returns or accountant statements.
Now how does the SBA fit into the bank vs. investor matrix?
The SBA loan program is designed by the U.S. Government to assist small businesses in obtaining capital that the conventional lending market cannot provide. The SBA does this by putting the full faith and credit of the U.S. Government behind a portion of the loan. The loan guarantees that the U.S. Government provides for commercial loans often act as the secondary source of repayment for a bank.
The loan program does a couple things; The SBA loan program allows the bank to provide a much higher loan-to-value than would otherwise be possible. Also, in some cases, this financing can be at below market rates. As a result, I strongly recommend that owner-users of commercial real estate at least look at the SBA loan program when considering financing.
If you would like to talk about any sort of lending issue I would be pleased to speak with you. I can assist you or your clients with a wide variety of loans, and not just the SBA loans. Please call me even if you have a question about a loan that I am not part of. I have almost 30 years of experience and am always happy to help.
Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com
Offering equity is giving an investor a share of the future profits of the organization in exchange for that investor providing capital. An example of this would be the stock market. Start-up companies often give equity to investors because their capital needs can exceed the amount of money they could reasonably hope to borrow. Equity can be structured many ways from buying stock, to a friend buying into another’s business.
The benefit of offering equity is that if the business fails the investors lose their money and there is no remaining obligation. The downside of offering equity is that if the business succeeds then the money paid to investors will eventually far exceed the amount paid for a similar amount of capital from a borrowed lender.
Most small to medium sized businesses that seek capital try to get a loan from a bank as opposed to offering equity in their company. However, the downside of getting a loan is that the bank expects/demands to get its money back. It will be a problem for someone if the business does not generate the cash to pay back the loan.
Since a bank’s profit on a loan is limited to the interest paid and their potential loss can be up to the amount owed, they have to be very careful when making a loan. As a result, most banks will look for at least two ways for the borrower to repay his loan.
Having more than one way to repay the money that a company is seeking is one of the main differences between being able to be a borrower or having to offer equity instead.
One of the first questions that a bank will ask a borrower is, ‘How are you going to pay the bank back if your business does not succeed as well as you would like it to.’ If a borrower wants to get a loan there needs to be a good answer to that question. If this question can’t be reasonably answered then instead of looking for a loan one should be looking for investors.
Often times some sort of collateral is used as the secondary source of repayment. For banks that make real estate loans, it is the property that serves the secondary source of repayment. For this reason banks try to limit the loan-to-value it provides on a transaction to a level that will allow it to recover loan funds in the event of a default.
The other thing that banks look for when deciding to make a loan is how much the borrower’s own funds will be put into the transaction. The unofficial term for this is “skin in the game.” A bank wants to know that the borrower has something to lose if there is a problem with the loan.
Having the ability to put your own funds into a transaction is something banks look for in a borrower. Without some skin in the game, you would be looking for equity.
Cash flow – I discussed cash flow in a previous e-mail. Suffice to say a borrower will have to show the ability to pay back a loan based upon tax returns or accountant statements.
Now how does the SBA fit into the bank vs. investor matrix?
The SBA loan program is designed by the U.S. Government to assist small businesses in obtaining capital that the conventional lending market cannot provide. The SBA does this by putting the full faith and credit of the U.S. Government behind a portion of the loan. The loan guarantees that the U.S. Government provides for commercial loans often act as the secondary source of repayment for a bank.
The loan program does a couple things; The SBA loan program allows the bank to provide a much higher loan-to-value than would otherwise be possible. Also, in some cases, this financing can be at below market rates. As a result, I strongly recommend that owner-users of commercial real estate at least look at the SBA loan program when considering financing.
If you would like to talk about any sort of lending issue I would be pleased to speak with you. I can assist you or your clients with a wide variety of loans, and not just the SBA loans. Please call me even if you have a question about a loan that I am not part of. I have almost 30 years of experience and am always happy to help.
Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com
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