As a major, nationwide SBA 7(a) lender, we espouse the program’s power and flexibility. But let’s face it; it’s a great loan to acquire a business, a building, or a machine, but a little clunky for the day-to-day needs of a business, especially one that’s growing.
I’d like to use my monthly blog space to talk about the features of a term loan, focusing on the SBA 7(a) loan program, what it’s good for, and where it falls short, then transition to three other types of financing that can complement it.
A term loan is a type of loan that provides a borrower with a lump sum of cash up front, which is then repaid over a set period of time (the “term”) through a fixed or floating interest rate and a specific schedule of payments. Think of it as a standard mortgage or a car loan but often used by businesses to finance major investments like equipment and real estate. The SBA 7(a) is a term loan, typically repaid over a ten- or twenty-five-year term with monthly payments covering both interest and principal. The advantages of an 7(a) loan when compared to conventional term loan is higher advance rates (so, lower down payment), longer repayment terms (also called “amortization period”), and (from lenders like us), the reliance on cash flow rather than collateral, making it the perfect loan to acquire a business.
However, the needs of a business rarely stop with major investments. In fact, the success of a business is as dependent on how it manages cash flow than it is on the more significant capital outlays. Here is an example: a distribution business receives a major order from a retailer and needs cash to buy inventory. And another: a staffing business lands a lucrative contract with a reputable client, but with 90-day payment terms. It pays its employees every two weeks, generating a significant shortfall in cash.
To address these needs, three forms of loans come to mind. In no particular order:
A revolving line of credit (a “revolver”) is a flexible financing arrangement that allows the business owner to borrow money, repay it, and borrow it again up to a pre-approved limit. Unlike a term loan (where you get one lump sum and the deal is done once it’s paid), a revolving line stays open as long as you are in good standing and may be renewed periodically. Most revolvers are based on a borrowing-base formula, for example 80% of account receivables and 60% of inventory, but some, like the ones we issue, are unsecured and don’t require a borrowing-base; very similar to a credit card.
Factoring (also known as accounts receivable factoring) is a financial transaction where a business sells its unpaid invoices to a third party (called a factor) at a discount in exchange for immediate cash. Instead of waiting 30, 60, or 90 days for customers to pay their bills, the business gets most of the money right away to use for its daily operations. Factoring is an important financial instrument in many industries such as distribution, staffing, and transportation. As an FYI, Gulf Coast Small Business Lending has a sister company that provides factoring.
Finally, the more exotic purchase-order or trade finance. Use case: a distributor receives a large order from a retailer and must import a container of goods from overseas. The manufacturer requires payment before loading the container. The revolver isn’t applicable because in general lenders don’t advance against inventory while it’s being transported. It also doesn’t qualify to be factored because an invoice is not issued until the ultimate customer takes possession, which can be weeks after the order has been placed. Enter purchase-order finance. A handful of lenders advance the full amount of the purchase order to bridge the need until it converts to an invoice. When the goods clear customs and ship to the customer, the advance is either termed (paid off) or converts to a more traditional factor. Again, Gulf Coast Small Business Lending has a sister company that provides trade finance.
To summarize, it takes more than a term loan to run a business, especially one that’s on a steep growth curve. There are several borrowing options to finance the working-capital needs of a business. If you or your clients have a need, our team (and our sister companies) would be happy to assist. Reach out to one of our experienced team of SBA professionals today. You can find their contact information here: https://gulfcoastsba.com/our-people/.