There are two main types of financing for a business, debt or equity financing. Debt financing tends to be the type of financing you receive from a traditional bank loan and equity financing tends to be financing you receive from venture capital into your business from outside investors. The benefit of debt financing is that it is finite and you will pay down the debt over time to a zero sum balance without any further obligation to the lender. The down stroke to debt financing is that traditional lenders will take a hard look at your business including how long it has been in existence, income from operation, expenses and will require hard assets for collateral for the loan. Additionally, lenders will most certainly want you (and any other principals of the organization) to personally guarantee repayments of the loan. Another disadvantage of debt financing is that your organization will be burdened with some other type of regular payment (usually a monthly payment) depending on the terms and conditions of the financing and this can absorb critical cash flow, especially with small business.
The benefit of equity financing or venture capital is that you will be receiving money in exchange for equity in your business in the form of stock or some other form of equity like percentage of income or gross/net sales. A primary benefit of this type of financing is that typically there is no monthly payment requirement to investors. Instead, you are giving up ownership interest, most often, permanently.
Traditional lenders, banks for example, will look at your business much differently than venture capitalist. Bankers want a zero-risk or near-zero risk position when they provide financing and will rely almost completely on the operating economics of the business with little regard for “potential future growth”. They want to see strong cash flow backed up by hard assets before they do a deal—the ingredients that most small business lack or they wouldn’t be seeking financing, right? Venture capitalist, on the other hand, tend to consider the management team and the potential future growth of the business more heavily than actual operating numbers, especially for small business with large potential but few sales and little or no operating history. Although these two lender types vary in their approach to analyzing a business for funding, you can be sure that careful scrutiny of you business will be conducted…
Besides the actual operating economics and pro forma analysis, both types of lenders will look closely at two particular documents: 1. Your business plan. 2. Your bank or loan request package. These two documents, if assembled correctly, can make the difference between success and failure when dealing with either lender type.
There are plenty of free SBA related materials that tell you how to create blue-chip, boiler plate business plans but they tend to be written for perfect businesses and not the average Joe who is less than picture perfect. If you are seeking some type of financing for your business I strongly suggest that you visit our site and check out our business e-books. We have several that cover a variety of topics and there are specifically two that will be a real treasure for you to own. One is called Power Planning (a powerful report on writing a wide variety of business plans) and How To Raise Money For You Business (teaches you how to assemble professional loan requests packages). They are priced at $5 each and can be worth millions in the hands of the right person. I am not trying to hype product, I am simply giving you a heads up.
The secrets to getting financing from either type of lender is a closely held secret by financial and business brokers for a number of reasons. Chief among them is it forces people like you to do business with them and they earn commissions. The SBA materials, while good, do not have the street savvy to get the job done in most cases. The proof is in the pudding—what has the SBA ever done for you? The SBA is just another government back bureaucratic nightmare for most. We also have some links for venture capital firms in our business links area located on our site on the Smart Link Zone page—it’s all-free.
Give it some thought…. Your future may depend on it.
To your success! Copyright © 2006 James W. Hart, IV All Rights reserved
By: Jim Hart
Posts Tagged Principals
Equity Injection Vehicles – 401(k) And Other Retirement Plan Rollovers Under the SBA’s SOP 50-10(5)
Jul 4
It is no secret that documenting equity injection for SBA loans can be a painstaking task. In the past, borrowers often utilized home equity lines of credit as their source of injection. However, plummeting home values and SBA rule restrictions implemented in the SOP 50-10(5) have virtually eliminated this source. Accordingly, borrowers are increasingly providing equity injection in the form of qualified rollovers of their existing 401(k), profit sharing plan or other qualified retirement account (collectively referred to herein as QRAs). To document this form of equity injection, lenders must conduct a unique analysis.
Lenders must first be able to identify a QRA rollover. In a rollover scenario, the QRA purchases some percentage of the borrowing entity’s stock. If the QRA owns at least 20% of the borrowing entity, pursuant to SBA regulations, it must provide a guaranty. By definition, QRAs cannot provide guarantees. Since lenders cannot obtain the guaranty of a QRA, the previous SOP required lenders to apply to the SBA’s Associate Administrator for Financial Assistance (AA/FA) for a guaranty waiver. Because an externally imposed legal restriction (ERISA) prevents QRAs from providing guaranties, the AA/FA was able to waive the SBA’s guaranty requirement. When the AA/FA did grant a guaranty waiver, all principals and beneficiaries were required to pledge their personal and unlimited guaranties. Under the SOP 50-10(5), lenders are no longer required to obtain a waiver from the SBA. Nevertheless, lenders still must obtain the same documentation as if they were submitting a waiver request, including securing the unlimited guaranty of all principals and QRA beneficiaries.
There are three scenarios in which lenders are prevented from documenting a guaranty waiver. First, a QRA cannot purchase the stock of an EPC. The AA/FA did not possess the authority to waive guarantees in these instances, and by extension, lenders do not have this authority. Next, a QRA cannot own 100% of the borrowing entity’s stock. ERISA rules state that neither a QRA nor its individual holder is permitted to incur debt, which prevents the beneficiary/principal from providing his or her guaranty. This situation is ineligible because any beneficiary of a QRA must provide his or her personal guaranty when the QRA owns 20% or more of the borrowing entity. Finally, the borrowing entity cannot be an S-corporation. The professionals who establish these QRA rollovers have stated that in order to be eligible, the entities must be C-corporations. Lenders can verify this information with the professional firm that facilitates the rollover.
Provided none of the ineligible scenarios exist, lenders must next confirm that several requirements are met. Most importantly, individual owners must pay for their stock in an amount that is commensurate with their ownership percentage. In other words, the price per share paid by individuals must be equal to the price paid by the QRA for its shares, and the resulting ownership interests must be proportional to the price paid. Lenders should verify these amounts with the professional firm that orchestrates the QRA rollover and confirm that the funds were deposited in the C-corporation’s bank account. Secondly, if an individual’s spouse has any entitlement to the benefits of the QRA, he or she must provide a full unlimited guaranty. Lastly, an individual’s guaranty must be secured if the value of the business assets securing the loan is less than the amount of the loan.
The final piece of documentation lenders must obtain is an opinion letter from ERISA counsel containing the following: (1) a description of the type of retirement account (the Plan) that owns at least 20% of the business; (2) the specific cite under the IRC that describes the type of Plan; (3) the specific cite under IRC that delineates why the Plan cannot take on any liabilities; and (4) a statement of how the Plan got to be or will be “qualified”. If the Plan is already qualified, counsel must provide IRS documentation showing how it achieved qualified status. If the Plan will be qualified in the future, ERISA counsel must provide (1) a statement of when application was made to the IRS for determination of “qualified” classification; (2) a statement that in the counsel’s opinion, the application will comply with the IRC and ERISA regulations; and (3) a statement that upon final determination from IRS, the Plan trustee will provide the lender with a copy of the approval.
The reasoning behind the prior SOP was not simply to assist lenders in documenting the absence of an otherwise required guaranty, but also to insure that the Plan had or would have obtained “qualified” status from the IRS. A proper QRA rollover will not incur early withdrawal penalties. However, if an unqualified retirement account were to purchase the shares of the borrowing entity, it would incur hefty early withdrawal penalties. The IRS would likely assess these penalties against the borrower within the first loan year and potentially cause a loan to default. Because the QRA funds are a portion of the borrower’s equity injection, this early default could jeopardize the SBA guaranty. In conclusion, in order to preserve the SBA guaranty and facilitate the success of their borrowers, lenders must diligently document QRA rollovers.
By: Annie C. Johnson, Esquire