By Bruce Hurta
Small business owners are gamblers. They are continuously making decisions based upon weighing the risks involved in their choices. In general, the greater the risk assumed the more likelihood of increased profit (or loss). When taking on new debt or obligations for ones small business, the small business owner wants to balance their risk/reward ratio for a satisfactory result. Will the increased obligation increase the company’s success or will it become a burden? If interest rates are variable, which way will they move during the life of the loan? If the interest rate is fixed for the life of the loan, will it be too high in comparison to the variable rate option?
SBA vs. Conventional Bank Loans
The last question posed in the above paragraph is critical. The answer to that question is affected by the term of the loan and that leads to one of the greater benefits of SBA loans versus conventional bank loans for small business financing. The SBA government-guaranteed loan program provides long-term, permanent financing for the small business. SBA loans which are used to purchase, construct, remodel, expand, or refinance small business real estate have a repayment term of 25 years. SBA loans not used for small business real estate have a term of 10 years. Initially, it appears that conventional bank financing provides similar repayment terms. Banks, however, are short-term lenders.
The Long & Short of Loans
Bank loans with long-term amortizations are not long-term loans. The risks to the small business owner are short maturity dates combined with a long-term amortization payment program. This means the entire loan comes due in one year, three years, five years, or some other term shorter than the full amortization of payoff of the loan. If I am a small business borrower whose twenty-five year real estate loan comes due in five years prior to full repayment, my loan has what is known as a “balloon feature”. The balloon is the remaining loan balance which all comes due all at once. Usually, it is not a problem. Banks want loans for interest income and small businesses need the loan proceeds. Why not just renew the loan balance for another five years and move on?
In many cases, the balloon balance is renewed and the bank and small business borrower do move on. There are, however, circumstances that create renewal risk and circumstances under which the bank will not renew the loan. The small business borrower who took the funds five years ago did not know at that time some of the following circumstances:
- Who will own the bank or who will be in charge of management of the bank and its loan decisions when the balloon feature comes due?
- What will be the state of the economy and what will be the profitability of the business when the balloon balance comes due?
The loan renewal process is like the new loan approval process. It requires a new credit and financial evaluation on the part of the bank to grant the renewal. Because of this, the small business borrower is faced with loan renewal risk. This is just one more gamble the small business owner encounters in their daily management of their business’ affairs. Sometimes it is a relatively safe bet to accept the bank’s offer of a short-term loan with a balloon balance in the short-term. This is usually in cases where the business is strong enough and has a sufficient track record to move the loan to another bank if necessary. If, however, the small business owner wants long-term, permanent financing without renewal risk, SBA loans are an excellent option!
You can learn more about SBA lending and small business finance on Bruce’s blog at brucehurta.wordpress.com. For more information about SBA real estate loans for small businesses, contact Bruce Hurta, Business Lending Manager at Members Choice Credit Union, at 281-384-2595 or by email at [email protected].