Leaps of faith
>>Both borrowers and lenders take risks with SBA loans by Neil Orman Local recipients of Small Business Administration loans own different types of companies, but often have something in common: Their stories and persistence are inspiring.
Consider the example of Barbara Hensley, who lost both her sisters to breast cancer within two years of each other. After working through her grief, she came up with a business plan that combined a nonprofit foundation and for-profit retail store that helps fund breast cancer research.
According to the plan, Hope Chest for Breast Cancer would sell high-end furniture, clothing and other accessories donated by individuals and companies, and contribute a major portion of the profits to research.
It wasn’t the sort of enterprise banks typically finance. Nevertheless, Hensley won a $750,000 SBA loan from Wells Fargo, and she used it to open her first store in Wayzata last November. She is planning to open a second location soon and aims to have 50 stores within five years contributing $10 million annually toward breast cancer research.
“It will take an enormous amount of money to make a difference in this disease,” Hensley says.
Then there’s a single mother who worked as a waitress and manager for Perkins Restaurant & Bakery locations for more than 20 years to support herself and five kids. Last fall, Debra Pedro secured an $855,000 loan to buy her own Perkins in Maplewood. She says the lender who eventually backed her, St. Anthony Park Bank in St. Paul, was “excited that this lonely single mom on the East Side was going to get this Perkins.”
Both these women would have had a hard time getting regular bank loans, which typically are reserved for proven businesses. SBA-guaranteed loans tend to be less restrictive because they are backed by the government.
There are several methods through which these loans are financed. Most often, a bank lends the money and the SBA guarantees 50 percent to 85 percent of the loan. In the case of real estate loans, the SBA often contributes part of the money itself through an entity known as a certified development corporation (CDC).
Borrowers also have longer terms to repay the loans: 20 to 25 years versus as few as a couple of years for conventional loans.
But even SBA loans aren’t easy to get, particularly in difficult economic times.
Pedro searched for about a year before she found a bank and was rebuffed by four banks. In some cases, she didn’t even get her call returned.
“I had come to the conclusion that banks give money to people that have it, not to people that need it,” Pedro says.
Then she mentioned her situation to a regular restaurant customer, Ryan Kelly, the son of St. Paul Mayor Randy Kelly and a banker at St. Anthony Park Bank. He helped her set up a meeting with his bank.
Bankers there “told me about the SBA program and within a week I got a proposal saying they would do the loan,” she says. “I just about had a heart attack, because they were the first ones even interested.”
Hensley, who was unusually well prepared for the money-raising process, also got turned away by the first bankers she contacted. She went into a meeting armed with a 50-page business plan that included an appendix listing every conceivable competitor in the Twin Cities.
“They turned me down flat,” says Hensley.
She says she surprised them by requesting another meeting to find out why she was rejected. Among the reasons they gave her: They didn’t like the way a business modeling software program she had used treated capital, and they didn’t want to finance a retail business.
“I suspect they didn’t want to fund a woman, too, although they didn’t say that,” Hensley says.
She wasn’t as discouraged as Pedro, however, because she had a strong relationship with Wells Fargo Bank.
“I thought it would be a good idea to try and get two loans” to spread the risk, says Hensley, who has 25 years of business experience including 14 at Honeywell in a variety of managerial roles. “But I always expected the main one would be from Wells Fargo.”
It turned out she only needed one loan, and Hensley was right: Her existing relationship with Wells Fargo smoothed the way for her. She founded the Hope Chest for Breast Cancer last November.
Many loan types
There are a variety of SBA loans. The most common are 7a and 504 loans. 7a loans, the type both Pedro and Hensley received, have 25-year repayment terms and can be used for a wide variety of purposes. In addition, banks can make 7a loans without involvement from the SBA if the government designates them “preferred” lenders based on a review of their policies, practices and loan portfolios.
504 loans, which have 20-year terms, can be used only for the purchase of real estate or equipment. These loans also must be made by a combination of a bank, which contributes 50 percent, and a CDC, which pitches in 40 percent. The borrower is responsible for the other 10 percent.
Diversified Manufacturing Corp. of Newport has received two 504 loans from Western Bank and the St. Paul Metro East Development Corp.: one for $450,000 in 1994 and another for $1 million in 2002. The 15-year-old contract manufacturer makes personal care products such as shampoos and skin products, household cleaners and other chemical specialty products for a variety of private label customers.
It used the first loan to acquire a 34,000-square-foot plant and the second to expand into a facility that quadrupled its space.
“Had SBA loans not existed, I would not have been able to purchase my building and do the expansion,” says Rishikesh “Ram” Motilall, the company’s founder and president.
The fact that even Motilall, a good risk in terms of SBA loan recipients, would have so few options testifies to the challenge of obtaining conventional bank financing. For example, his company has a lot of hard assets in its manufacturing equipment that can be used as collateral. Those assets weren’t enough, says Motilall.
“Most of the equipment we have, like tanks and filling machines, doesn’t have a lot of marketability,” Motilall says.
The main advantage of 504 loans: the payment to the CDC is fixed at a low rate. Borrowers must make monthly payments both to a bank and the CDC. But banks often set their 504 interest rates lower as well because they are considered safer loans.
A new type of loan introduced last year is called SBA Express, which offers the agency’s first guaranteed line of credit.
Paperwork on the Express is minimal compared to most loan types. However, these loans are small, with a cap of $250,000 versus about $2 million for 7a or 504 loans. Also, the SBA guarantees only 50 percent of the loan, rather than the usual 75 to 80 percent.
Express loans tend to go to particularly high-risk borrowers such as start-up service companies. For example, a Minneapolis design firm used a $20,000 Express line of credit from Highland Bank to help it get started. 20 Below Studio, which offers architectural and interior design services, also received a $30,000 7a loan from the bank. The firm used the term note to renovate the space it was moving into and the line of credit for working capital.
20 Below Studio was co-founded last June by Heather Rose-Dunning and Joseph Hamilton.
Rose-Dunning says they sought a small loan so they would not have to put their lives in hock.
“We were originally looking for $60,000 because we knew we needed $50,000 and we thought it would be safer to ask for a little more,” Rose-Dunning says. “But if we went up to $60,000, we would have had to mortgage our houses…And I didn’t want to take my husband down with me if we fail.”
The co-founders formerly worked together at Ellerbe Becket, a Minneapolis-based architecture, engineering and construction firm.
20 Below Studio has proven worth the risk, according to Kim Storey, Highland Bank’s vice president of SBA lending, in St. Paul.
“The company has exceeded projections and they have hired at least two additional people,” she says. “This is a great success story for people who want to go out on their own and start a company.”
Storey says she thinks that the Express program fills an important need.
“A lot of companies just need lines of credit, not term loans,” Storey says. “We couldn’t do that before. Now we can.”
However, some bankers, including Sheil Nelson of Associated Bank, criticize the Express program. Nelson says he doesn’t think banks can make money on Express loans. He expects most of his bank’s bad loans at the end of the year will be Express loans.
“I know that it’s politically the wrong thing to say, but if I’m running a bank to make money, I wouldn’t make too many Express loans,” says Nelson, vice president – SBA division manager of Associated Bank in St. Paul.
Two main criteria
Bankers look at two main criteria to evaluate potential loan recipients: the capacity of the borrower to repay the amount and the character and experience of the people running the business. SBA customers tend to be weaker than traditional loan recipients in the first category.
Banks making SBA loans usually must make a leap of faith based on the individuals involved in the loan.
For example, Pedro had never owned a business, but she had practically run the Perkins restaurant where she worked, her banker says.
“Deb was really the current energy behind the success of this business already,” says John Kimball, vice president and head of SBA lending for the Sunrise Bank group (St. Anthony Park State Bank and University Bank in St. Paul, and Franklin Bank in Minneapolis).
Diversified Manufacturing Corp. was an exceptionally good risk, its banker says.
“Ram was a long-term customer of the bank, and a good manager and decision-maker,” says Al Mueller, vice president of commercial loans at Western Bank. “His business was growing and his expansion seemed warranted.”
Bankers offer several pieces of advice to small-business people considering SBA loans. They urge them to start out by researching the different loan programs on the SBA’s Web site (www.sba.gov). They also stress the importance of taking the time to find the right banker.
“Look for a banker that understands your industry and that you have a good rapport with,” says Nelson of Associated Bank.
The number one advice from SBA borrowers: prepare well before meeting with bankers. For startup businesses, that includes creating a thorough business plan with a breakdown of the venture and financial projections.
“Get that business model down pat,” Hensley says. “Write it down and get people to give you feedback on it.”
Getting a loan is a major commitment, and SBA customers often have to refinance or get second mortgages on their homes in order to secure a loan.
“It’s a little scary getting a loan like this,” Pedro says. “If you lose, you can lose big.”
Nevertheless, the SBA’s Minnesota District office is among the most active in the U.S., ranking ninth in the nation for loans approved during fiscal 2002 even though Minnesota is only the SBA’s 26th largest market in terms of population.
