How to finance equipment and working capital long-term

Using the SBA Blended Maturity to Finance Working Capital and Equipment for up to 25 Years.

One of the primary goals of the business owner is the maximization of cash flow. At the end of the day, it comes down to “how much cash ends up in your pocket”. Many small business owners are under the faulty impression that the goal is for the business to be profitable, and although for the most part a profitable business also produces positive cash flow the goal should always be cash. This is something that a junior credit analyst learns the first few weeks on the job “Net income does not pay the loan, cash does”.

Financing short-term assets is always a strain on your cash flow. If a commercial borrower walks into a financial institution looking for money, the lender will match the loan to the needs. If you need working capital financing, the lender will probably offer you a line of credit with yearly maturity. If you are looking to buy new computers or a large printing press, the lender will probably offer you a three-year term loan for the computers and a more relaxed five or seven year loan for the press. The goal for the lender is to meet your financing needs while minimizing the risk to the financial institution. It is called the matching principle, and it is a basic tenet of credit risk management.

But, what would you say if I told you that you could get an SBA guaranteed loan with a 25-year maturity, and use some of the proceeds for inventory, working capital, and equipment?  Think about the cash flow implications, even if you had to pay 2% more in the rate. This is shown better with some math, so assume that you are buying a piece of equipment, and need a $10,000 loan. You can either repay the loan at 6% over five years (option A) or at 8% over 25 years (option B).

 

Assumptions  

A

B

Loan Amount

10,000

10,000

Interest Rate

6.00%

8.00%

Amortization

5

25

DEBT SERVICE  

$2,325

$935

As a business owner, keeping $1,390 in your pocket every year might be worth more than the savings from the difference in interest.

Now if you are familiar with SBA, you are shaking your head and wondering what I am talking about. In fact, you might be shaking your head and thinking about the Standard Operating Procedures manual from the SBA that states loan terms must be appropriate for the borrower’s ability to repay and the use of proceeds and has the following guidelines about maturities:

  • Working capital loans should not exceed 7 years, unless a written justification is provided explaining why a longer maturity is necessary. In no case may the maturity on a working capital loan exceed 10 years.

  • Equipment loans should not exceed 10 years (or the useful life of the equipment)

  • Real estate loans must not exceed 25 years unless a portion of the loan is used for construction or renovation. If the use of proceeds of a real estate loan includes construction or renovation, the construction or renovation period may be added to the 25 year maximum maturity.

Welcome to the world of mixed purpose loans and blended maturity.

“When loan proceeds are used for multiple purposes (land & building, working capital, and machinery & equipment), the maturity may be the blended maturity based on the use of proceeds or up to the maximum for the asset class comprising the largest percentage of the use of proceeds”

This is a characteristic of the 7(a) SBA loan program, and in layman’s terms it means that as a borrower if you are looking for a long-term loan to acquire real estate, this would be a great time to bundle all of your financing needs into a single loan and benefit from a longer maturity. I found that expressing these concepts into a table is helpful. So lets assume that your business is purchasing a building to house its operations, and needs a $500,000 loan. At the same time, the business also needs two $100,000 loans for equipment and inventory.

 

Use of Proceeds

Amount

Percentage of Total

Max. Maturity

Building Purchase

$500,000

71%

25 years

Equipment

$100,000

14%

10 years

Inventory

$100,000

14%

10 years

Loan Request

$700,000

100%

25 years

Because the building purchase is the largest portion of the loan request, it is possible for the financial institution to take the maturity of the request to 25 years (matching the maximum maturity as it is the use/purpose with the largest percentage).

Disclaimer: Some of the information above was extracted from the SBA’s Lender and Development Company Loan Programs “SOP 50-10(5)” in effect during August 2012. Although the SBA has not changed its Standard Operating Procedures for a couple of years, it is always a good idea to take a look at them for changes.

For additional information about SBA financing, and funding your business you can read more by buying the following books at Amazon: The SBA Loan Book: The Complete Guide to Getting Financial Help Through the Small Business Administration
or Get Your Business Funded: Creative Methods for Getting the Money You Need

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