The Official Blog of the SBA 504 Experts

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Recasting a Federal Agency: A Turnaround Blueprint for the New SBA Administrator

The U.S. Small Business Administration’s (SBA) named a new Administrator: Steven C. Preston. This 22nd Administrator in has quite a job ahead of him, and among his many tasks are to resurrect the Agency — in image and in effectively delivering its programs. This is no small feat, and he’ll need all of the suggestions and support available to do this. As someone with extensive SBA lending experience and a small business owner myself, I propose this blueprint to successfully turnaround the SBA and help make it more relevant and effective than ever.

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On July 10th, the U.S. Senate confirmed the U.S. Small Business Administration’s (SBA) new Administrator, Steven C. Preston. Taking over a much maligned federal agency of late, the 22nd Administrator in its history has quite a job ahead of him, and among his many tasks are to resurrect the Agency — in image and in effectively delivering its programs. This is no small feat, and he’ll need all of the suggestions and support available to do this. As someone with extensive SBA lending experience and a small business owner myself, I propose this blueprint to successfully turnaround the SBA and help make it more relevant and effective than ever.

First, Administrator Preston needs to help defeat the stigma that presently exists of the SBA as a four-letter word. The SBA has an image problem, plain and simple. Far too many American entrepreneurs — and ironically, bankers — believe the SBA is a typical, ineffectual, government bureaucracy with only hassles to offer them. These negative connotations may have been true in the distant past, but couldn’t be more false today. More recently, the SBA has come under attack from a minor, but vocal group of academics and think-tank theorizers who have questioned its very relevance at all.

The main problem lies in the SBA not effectively confronting the misinformation and stereotypes about it that persist, and in not proving its worth and justification for being. The best way I know to confront a problem is to first acknowledge that one exists and then take it head-on. The bad rap the SBA receives from the typical American small business person lies mostly in the past deluge of paperwork involved and perceived red-tape with its basic loan programs. This simply isn’t the case anymore, but the SBA has done a poor job of telling its story. Under the previous Administrator, Hector Barreto, much streamlining of loan application processes was accomplished as was the removal of slow and unnecessary approval steps. In the past, people spoke of SBA loans taking “months upon months” to get done, but these same SBA loans now take only weeks; and with competent private sector lenders delivering its loan programs, it often takes no more time than conventional bank financing to get an SBA loan approved and funded anymore. Administrator Preston needs to launch an all-out assault on the lingering myths and misperceptions.

The first place to target this recasting is with what appears to be the SBA’s biggest ally: the commercial lending community. Most people in the know will tell you that the SBA has a “love/hate” relationship with lenders. There are many reasons for this, including: most SBA loan programs are originated or sold by lenders, relegating the SBA to a role of order-takers rather than proactive sales consultants (reducing their “spotlight”); most SBA loan programs are delivered not with SBA funds, but with lender funds, relegating the SBA to a role of simply “guaranteeing” the loans (turf battles ensue); many bankers will not use an SBA loan product if given a choice for fear the SBA wouldn’t honor their guarantee if the deal blew-up (stubborn doubt about its veracity); many bankers would not use an SBA loan product if given a choice because of the perceived “extra hoops” and loss of complete control over the process (the hassle argument); and most commercial bankers will not use an SBA loan product if given a choice because it may reduce their personal income by restricting loan sizes (the pocketbook issue). So let’s take on these dirty little secrets of SBA lending that Administrator Preston needs to know about.

Far too many bankers are still bitter about SBA guarantees being taken away on defaulted loans in the past, when in most cases, these same bankers have no one to blame but their own careless oversights and sloppy credit decisions. The SBA was just performing its fiduciary duty by protecting American taxpayers and not honoring guarantees on deals that probably relied too heavily on them. SBA lending is often more art than science, but sound loan underwriting principles need still apply. Failing to properly collateralize an SBA loan (by a banker) should not be grounds for the SBA and American taxpayers to take it on the chin. There’s no need to continue bashing the SBA over past mistakes made by originating bankers in the first place.

Far too many bankers (who influence many more others on this subject) think SBA loans are only for the worst borrowers and often flippantly quip, “The guarantee will protect us from any risk.” This is a terrible misperception and one that naturally leads to the SBA’s stigma as a “lender of last resort.” Is it any wonder that only 4% to 20%, depending on the study, of American businesses have been helped by the SBA? What too many bankers fail to understand and the SBA does a terrible job of promoting, is that many SBA borrowers are very “bankable,” and several of the SBA’s loan programs are substantially superior to conventional bank financing. The majority of small business owners have to be told about an alternative, however, in order to know of its advantages, and therein lies the major problem and why I’m advocating that the new Administrator start selling. He can’t be fearful of explaining why having the full faith and credit of the U.S. government makes his loan programs better than private sector alternatives and with newly implemented reforms, much better than in the past.

While I may admire the maverick approach of the previous Administrator or our President, it would be more helpful if this Administrator would immediately realize that he doesn’t have the sound stage of Hollywood or the world’s stage of a U.S. President. He doesn’t even have as many of the allies as he thinks he might, despite politicians generally blathering on about their unyielding support for small businesses. He’s got to sell his Agency, while he reforms it.

It may very well be true that politicians everywhere will echo the presumed virtues of small businesses, but because the small business segment is so diverse and dispersed, their voice from a unified lobbying effort is seldom heard but from a select couple of organizations – and even they haven’t been very happy with the SBA lately. Politicians generally ignore small businesses, their public platitudes notwithstanding, because of this paradox: small business owners are too busy manufacturing widgets, seeing patients or meeting payroll to fundamentally unify like their big business brethren. Any big business with a fleet of lobbyists wouldn’t be foolish enough to ignore the great lending programs provided by the SBA, if only they could qualify.

Take the still under-utilized SBA 504 loan program, for example. Its government-guaranteed second mortgages make up nearly half of these projects, and the interest rates on 504 bonds are the least expensive debt available to most small business owners looking to purchase or construct commercial real estate. Typically being up to 150 basis points cheaper than conventional bank financing, while having longer fixed interest rate terms, longer amortizations and at a third to half the equity requirement, these loans often foil the critics who carp about how fee-laden SBA loans can be. But do you hear many bankers ever mention this program and the fundamental advantages it conveys? No. To do so would acknowledge a superior loan product to their own banks’ conventional loans and would result in lower first mortgage amounts for that particular commercial loan officer, which ultimately means lower commissions or bonuses. Most bankers would rather keep the 504 locked away in a closet, only to be brought out: if a competitor mentions it; if they can’t sell Prime-based, floating-rate SBA 7(a) loans (they’ll try, even with this program’s 7%+ historical default rate versus around 2% for 504’s); or if they don’t really like the credit quality of the borrower or his industry and therefore want to limit their exposure by reducing their first mortgage substantially. This is not the way to promote a superior loan product to very capable and healthy small businesses. If bankers won’t mention the virtues of it, then the telling of the “great story” falls to the SBA and other enlightened firms. When perceptions about it are largely false, the SBA owes it to its core constituency (America’s entrepreneurs) to get the truth out in the public forum, early and often. Administrator Preston needs to start championing the strongest weapon in his arsenal: 504’s. No less than the American economy is at stake here, in as much as better loan programs can result in more efficient use of capital which results in better production, more job creation and higher profits.

As the Federal Agency that deals more closely with America’s entrepreneurs than nearly all others (the IRS being a notable exception), Administrator Preston needs to bring to bear some of his private sector experience and ideas to the Agency. A great start would be the following: take the disaster loan program away from the SBA since the Agency isn’t making other direct loans anymore; end the Women’s Business Centers and any other duplication of what Small Business Development Centers (SBDCs) and SCORE do; instead of increasing the 7(a) loan ceiling, just remove it entirely, like with 504’s, and merely determine the maximum government guaranty; eliminate the Express loan program since it overlaps with 7(a) loans; continue to require the 7(a) program (just like the 504) be zero-subsidy (contrary to what Congresswoman Velazquez believes, the higher fees of the past two years for 7(a)’s to be zero-subsidy are not the reason for fewer 7(a) loans – SBA lenders have trouble selling a loan product linked to a short-term index like Prime that has increased 17 times or 425 basis points in just over two years); and last, but not least, mandate that all future SBA guaranteed loans involving commercial real estate be done with 504 loans only (including finally allowing refinances under this program).

This last recommendation will surely chafe mostly 7(a) lenders, but it will have the effect of making only the SBA’s best loan program for commercial real estate available for that purpose, while freeing-up plenty of 7(a) funds for start-ups, working capital, business acquisitions and other non-real estate needs. While the 504 program funded over $15 billion in total project costs this past fiscal year, implementing this action could easily double the program in the near future. It would also serve to avert another shutting-down or temporary suspension of the 7(a) program like those that occurred a few years ago (since so much of the annual 7(a) budget gets depleted by real estate transactions), and which left the Agency with two black eyes and a PR nightmare it’s still recovering from. Duplicity of SBA loan programs is not needed, especially when 7(a) and 504 loans can be combined, when requested, for borrowers that need financing for a business acquisition which includes real estate.

Plain and simply: the SBA exists to level the playing field for small businesses. It has never guaranteed outcomes, just opportunities through their loan guarantee programs. These are not actual subsidies, but government guarantees in the event that pledged collateral is not sufficient to recover losses. Anyone that doesn’t believe this Agency and these programs are needed and that small businesses don’t get pushed around by big businesses, clearly hasn’t seen receivables stretched by big businesses past acceptable standards, for instance, because it helps big business cash-flow and/or because they can. To even suggest that big business competes effectively with small business on job-creation and innovation, as some have recently, is far-fetched at best. But, this is why the new Administrator must circle the wagons right away.

The SBA’s budget, by itself, has shrunk 60% since 2000. Yet during the same time, SBA-guaranteed programs have grown to over $28 billion this past fiscal year. For some SBA programs, like the 504, over 100% growth has been achieved in just the past five years alone. Researchers shouldn’t call for the abolition of an agency like this. Rather, they should call it what it is: efficient. We taxpayers should wish these kinds of results from more federal agencies, particularly from ones that operate zero-subsidy or “revenue-neutral” programs.

A recent survey of government agencies found the SBA had the least happy employees. The primary reason for this, I believe, is that increased accountability and newly implemented, common-sensical policies and procedures – things the private sector faces daily – now require SBA employees to hustle when they frequently didn’t in the past, much like most bureaucrats. Aren’t these results the kind we want from our government and our tax dollars? Administrator Preston will just need to motivate his troops to see his new Agency vision with reforms like I’m suggesting.

In this day and age, a nation’s economic strength is the modern equivalent of warfare (sporadic guerilla fighting with Islamo-facists aside), and it is therefore necessary for our nation’s future to have government-supported economic development. Government-guaranteed programs by the SBA are a terrific way for our government to not be in economic development, but to support its progress, the economic stabilizing outcomes this progress produces and the continued growth of our economy.

The SBA needs better advocates and America’s small business owners need to know that better alternatives are available. Neither of them need misinformation or the pot-shots that result from some think-tankers’ fallacies.

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SBA 504 Loans: Eight Quick Tips You Need to Know Now

SBA 504 Loans: Eight Quick Tips You Need to Know Now

Get organized – most competent lenders can give you a checklist of their needed documents immediately. Full documentation loans (like SBA 504’s) are worth spending the extra time on in order to get organized and shave a couple hundred basis points (100 basis points equals 1.0%) off interest rates. This will add up to tens of thousands of dollars, if not more, over the life of your loan.

Get pre-approved – this saves you time by knowing what you can afford to “shop” for. There is no sense wasting your time or your real estate broker’s time looking at $2 million buildings if you can only afford a $1 million one. Lenders have gotten very efficient and accurate with these (assuming you provide the documents they need to examine), often issuing these in as little as 24 hours.

Consider low down payment and longer-term loans — this preserves your capital for better utilization, keeps your cash flow high, and allows you to redeploy the “capital savings” into other profit-generating business activities. Small business owners no longer have to put down 20 percent to 30 percent or accept fifteen-year terms with five-year fixed rates from ordinary lenders to get a “good deal.” The SBA loans we provide (504’s) are a perfect antidote to ordinary loans. The key point here is to actually do something with the “capital savings” you get from only putting a third to half as much equity down and getting up to 25-year terms.

Buy commercial real estate for the “right” reasons – if your likely exit strategy someday is not an IPO, but rather selling or simply closing your business, then it makes great sense to effectively “pay yourself rent” rather than some absentee landlord. As soon you have the capital for the down payment, you should consider turning that rental payment into a mortgage payment that will at least give you something for your effort – just like buying a home instead of renting an apartment. By doing this, you no longer will be throwing away your lease payment monthly, but building equity in an appreciable asset that also offers multiple tax advantages and income-sheltering opportunities not available with leasing.

Consider adding other furniture, fixtures and equipment (FF&E) into your SBA 504 loan — as long the FF&E costs are still a minority of your overall project costs and the FF&E have relatively long useful lives, you will get to amortize these on the much longer real estate terms (which will greatly improve your cash flow) at the same time that you depreciate these over shorter, allowable IRS schedules. This aspect, combined with your commercial property, gives you truly the highest cash-on-cash return for your total project costs when you employ 90% loan-to-cost SBA 504 financing.

Consider buying/building more square footage than you need right now — you can always grow into it, but this will also allow you to get some rental income until that time. In virtually all situations with SBA loans, you will have to occupy at least a simple majority within one year of buying the property.

Always establish a real estate holding company or what is known as an Eligible Passive Concern (EPC) to own your new property — the formation of a master lease between an EPC and your operating company is how you’ll tie the two together. If you later decide to sell your operating business, you can keep the real estate company (and by default, the real estate) from which you can continue cashing rent checks. It is in this way that owning your commercial property can become a great retirement asset for small business owners everywhere, all while “paying yourself” to do it.

Consider partnering with another business owner in your EPC if coming up with the down payment is tough – if you have a profitable business and your competent lender already pre-approved you for X dollars, this solution will allow you to gain the advantages of commercial property ownership even while you share the equity requirement and upside with another. Please understand that your new partner’s operating business will also have to be examined to commit to your loan, and don’t forget to always use good judgment when partnering with someone else. Make sure to clearly stipulate the buy-out provisions in your operating agreement or other documents ahead of time — disagreements do occasionally occur, but corporate entity documents are usually better at resolving disputes than personal memories.

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Listening to each other to build a powerful resource . . .

One of the greatest reasons we had for starting this 504 blog is that as small business owners ourselves, we recognize the importance of listening to and learning from our clients and our valuable referral partners. We hope this SBA 504 Loan forum will be a great resource for both business owners wanting to build or buy their commercial properties, as well as commercial real estate professionals like ourselves to learn from each other and more about 504 loans and their benefits.

504 Blog Entrepreneurs: what’s the good, the bad, and the ugly of what it’s like navigating through the commercial lending or commercial real estate process, and what other related experiences have you had in your own business? What advice would you like from us or the other commercial real estate experts involved with this blog? What advice can you share with other entrepreneurs in or about to start the process?

For our referral partners: what has been your experience with the clients you’ve worked with? What are their greatest concerns? What do you (as a real estate broker, mortgage broker, CDC, etc.) want to see from a lender? What would you like to know more about from your peers on the 504 Blog?