What Are SBA 7(a) Loans?
Matthew Gillman started his career in 7(a) lending, and walks through where the program fits a government contractor. A term loan up to $5 million over ten years at close to bank rates is excellent for equipment and refinancing, and the wrong shape for a working capital need that keeps growing. The part worth reading twice is what a 7(a) lien does to your ability to raise working capital afterwards.
What is the SBA 7(a) program?
Matthew Gillman: The SBA is not the one providing the capital. They provide a guarantee to SBA lenders, who provide the capital. There are non-bank licensees, and banks can make 7(a) loans as well. They are not all treated equal. The SBA has its general guidelines, and then each bank or non-bank overlays its own credit appetite and its own policies on top. Some SBA lenders are great at acquisitions and some will not do them. Some like veterinarians and doctors offices, others like government contractors or construction companies. They operate under the same program and they are not the same lender.
The program is typically capped at $5 million, with terms from ten to twenty five years depending on whether there is real estate. The flagship for a business with capital needs that are not real estate related is the ten year term up to $5 million.
Can a bank be stricter than the SBA guidelines?
Tony Gray: The SBA sets its guidelines for what qualifies. A bank with less appetite in a certain area can choose not to take that risk. They can be more conservative than the SBA says. They cannot be riskier.
Matthew Gillman: It is no different from working with a specialty lender. Inside every bank there is a credit department, and a credit department is people, and people have backgrounds in certain industries. The makeup of the team drives what they are good at, because if you stick to what you know you provide a good service. There are 7(a) banks that are really good for government contractors. The question is whether it is the right program for where your business is in its lifecycle.
How does a 7(a) loan work for a professional services contractor?
Matthew Gillman: It is a term loan. Take the ten year with no real estate attached. It underwrites your cash flow, so your historical profitability matters, along with your time in business, and there are collateral requirements. People look at it as a working capital loan and it can be, but be careful how you use it, because it files a UCC on all business assets like any commercial loan. After that you are trapped in what you have already taken unless you pay the 7(a) off.
It is great for purchasing equipment, refinancing equipment and refinancing debt, because you get ten years to pay off a loan and that is unheard of in small business lending.
Why is a term loan wrong for a growing working capital need?
Matthew Gillman: If you win a contract or you have active contracts and you are growing, the thing that grows is your working capital need. If you take a 7(a) for a cash injection and keep going hard, you end up in a scenario where a company like ours requires a first lien on receivables, and the SBA lender says no, we have outstanding debt and you cannot go and get other financing. So do not take what you think you need without understanding the program. If you have a revolving capital need that is going to keep growing, a 7(a) is not right for you.
Flip it over. If you have been growing five years, you are doing $30 million in revenue, you see five to seven percent growth a year and you are profitable, you can run on your own working capital. That is the point at which you refinance out.
What is an intercreditor agreement and when do you need one?
Matthew Gillman: If you already have a 7(a) and now you are growing and you did not plan for that growth, and you come to us or another lender for working capital, what has to happen is an intercreditor agreement. Our company speaks with your existing bank and negotiates, which is standard, for us to provide working capital against the receivables while the SBA lender keeps their other collateral. But there has to be a reason the SBA lender is willing to do it.
If you are a services company you do not have other assets. They are not hard assets. You are not a manufacturer. You have no plant, machinery, equipment or inventory. You have people and computers and you provide a service. In those situations we often find the SBA lender says no, and I do not blame them.
Should you close both facilities at the same time?
Matthew Gillman: If you want a 7(a), go for it. But walk into the SBA lender and say you want to close your SBA loan with two facilities, because it is easier to close a deal with us and an SBA lender at the same time than to get the SBA loan and ask afterwards. They have to have a reason to give up collateral, and the reason cannot just be that it benefits the company. There has to be a benefit to the SBA lender too.
A good example is a janitorial services business with equipment it has debt on. Refinance that debt with a 7(a). We know 7(a) lenders, so if we work with one we already have agreements with, we can do both. The 7(a) lender refinances the term debt and we provide the revolver against receivables, because receivables are not an asset 7(a) lenders give much collateral value to. They look to inventory, plant, machinery, equipment, real estate, hard assets that can be liquidated in a default.
Can a new contract be carved out of an existing 7(a)?
Matthew Gillman: We do it all the time. A customer has a 7(a), we know the bank, they win an award billing a million a month. We present the case: this provides a ton of liquidity, the contract is profitable, this is pure opportunity. We have had SBA lenders carve that contract out so we can do a contract line, and both parties win. More consistent cash, they can take on more work, it is profitable, so there is more money to make the term payment.
The reason we get a yes fairly often is that the contract did not exist when the 7(a) closed. We are not asking for something on existing revenue that was originally underwritten. The business is good as it is today, and this contract was never evaluated.
What are the pros and cons of an SBA 7(a) loan?
Matthew Gillman: The pros are clear. You get close to bank rates, typically around prime plus 275, and a ten year term, which is unbelievable for a business loan. I would caution a GovCon though: a ten year term is great, but you may have a one year base and four option years to win, and you just took money for ten years. Understand your contract diversity risk so you do not get stuck paying off ten years against a couple of years of contracts.
The biggest con is not the UCC on all business assets, because that is normal in business lending. It is that they look to any and all available personal assets, especially if the loan is under collateralized. If the loan is a million and you only have $250,000 of collateral, which is almost always the case with a professional services business, they look at the equity in your home and file a second lien on it. They look at investment properties, brokerage and securities accounts. They have to, to be in compliance with the SOP. So it locks up anything and everything you have, and in exchange you get a great rate and a great term.
Is there a better program for small manufacturers supplying defense?
Tony Gray: On a typical 7(a) the SBA guarantees 75% of the loan, which reassures the lender. The SBA and the Department of War have since established the Smaller War Plants Commission, and eligible small manufacturers can reach the Made in America Loan Guarantee through the International Trade Loan program, which carries a 90% federal guarantee. It finances equipment, facility modernization, inventory, acquisitions and domestic capacity expansion, across munitions and their components, drones and one-way attack systems, microelectronics, strategic and critical minerals, shipbuilding and repair components, sensors, batteries, castings and forgings, and textiles.
Read more on this
- Loans for government contractors
- Asset-based lending, factoring or a contract line
- Contract line of credit
This is an edited version of the conversation: spoken repetition is removed and each answer leads with its point. Every figure and example is as said in the episode. For financing specific to your business, talk to us.
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