Understanding Your Funding Options

Pursuing Financing to Help Your Business Through the COVID-19 Pandemic

Businesses and nonprofits of all sizes are getting hit hard right now due to the impact of the COVID-19 pandemic. Many are worried about how they will stay afloat, while some have already closed their doors for good.

To address the financial crisis, governments and private institutions have released a variety of assistance programs. The SBA Disaster Loan (specifically the Economic Injury Disaster Loan) is the program that is receiving the most attention right now. The SBA is preparing to receive an onslaught of hundreds of thousands of applications over the coming weeks, and the SBA online application site is already struggling to keep up with traffic.

Thankfully, the SBA Disaster Loans are not the only option. There are multiple sources of funding still available to businesses in need. Below are some simple facts and explanations of the most popular funding options to help you carefully decide which option is best for you and your business.

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Disclaimer: We are not loan officers, nor are we financial advisors. We’re providing this information because we haven’t found a good resource that explains all of these options in connection with the current crisis. We’ve gathered this information from research we conducted as we have pursued funding for both ourselves and our clients. We’ve also run this information by our local Small Business Development Centers (SBDC) to check for accuracy.

Circumstances will vary from business to business, and from loan to loan. If you would like specific financial advice for your situation, please contact your local SBDC or send us a note so we can get you in touch with someone who can help.

Five Options for Funding

There are many sources of funding out there to help small businesses right now, but they all fall into one of the following five categories:

1. Government-Backed Disaster Relief Loans

Information about this loan is changing frequently. As of initial publication, the SBA is encouraging every business (including sole proprietors) to go through the initial steps to apply for an Economic Injury Disaster Loan.

The goal of the loans is to help businesses overcome the temporary loss of income as a result of the disaster. The SBA Disaster Assistance program is the most well-known source of government-backed disaster relief. This program provides loans of up to $2 million, but loan amounts will be for 6 months of operating expenses.

If you seek a loan over $25,000, you should expect to put up collateral (either business assets or personal property). The loans are at 3.75% interest for businesses and 2.75% for nonprofits, and may be used to pay fixed debts, payroll, accounts payable and other bills that can’t be paid because of the disaster’s impact. Terms vary based upon the individual applicant’s situation, but repayments can be as long as 30 years. Businesses are able to defer payments for 1 year, but interest will accrue for that year.

You can find more information on the SBA disaster loans on the Lord Fairfax Small Business Development Center’s website.

Other state and local governments are also providing disaster-related financial assistance. Forbes is maintaining a list of all federal, state, and local programs. None appear to be currently available from the Virginia state government, but we will update this post if the state opens any programs.

For businesses who have been operating in the City of Winchester for six months, the Economic Development Authority has established a relief loan. The maximum loan amount is $5000 for a 5 year term and no payments will be required for six months. The loans will also be interest free for at least the first two years, but the EDA will meet again in 18 months to assess if they should apply a 2% interest rate for the remainder of the term. You can find more information and download the application on the Winchester EDA’s website.

UPDATE: The newly passed CARES Act (H.R. 748) contains several new provisions to help small businesses. To learn more, you can read our summary here. 

2. Conventional Bank Funding

Banks are the top source of funding for businesses. There are two different funding products that banks provide: term loans and lines of credit:

  • Term Loans: Because they require a fairly lengthy banking history and excellent credit, term loans are typically best for established businesses. If your business doesn’t have a banking history or its own credit, you will need to use your personal banking history and credit. (This will tie your personal finances to your business’ finances. If your business has to declare bankruptcy, it will not absolve you of your responsibility to repay the bank.)

    Term loans function the same as the SBA Disaster Loans. If granted, you will receive an injection of cash that you will pay back in accordance to the loan’s terms (which are also dependent upon the application). However, unlike the SBA Disaster Loans, the fund can be used for any businesses expenses and have no maximum cap.

  • Lines of Credit: Like with term loans, lines of credit also have no cap and the credited amount and terms are dependent upon the individual’s application. The difference between a term loan and a line of credit is the manner in which you must pay back the money. Unlike a term loan where you are given the money all at once and then pay the loan back over time, lines of credit allow you to constantly pull money from the line and then pay it back. It provides you with a constant back and forth flow of money, instead of a one-time cash injection.

    You should ideally be paying back the line of credit at approximately the same rate that you draw funds from it. They are best to help with temporary cash flow problems (like if you struggle with collections or have lengthy invoice terms).

The current economic situation may make conventional bank loans appealing. With the stock, bond, and commodities markets dropping right now, investors are showing a massive shift to cash and there are fewer options available for banks to earn a good return on the deposited funds that they hold. Loan interest, however, provides banks with the stable income they need. Banks are eagerly looking for places to invest their money through loans, and small businesses (who have a good credit and banking history) provide them with good opportunities.

It’s a win-win scenario for banks and small businesses. Small businesses get the cash injection they need to survive or grow, and the banks receive a stable source of income from the loan interest. We have spoken personally with some of our local banks, and they are ready to work with businesses to help them through the financing process.

3. Traditional SBA Loan

The goal of traditional SBA loans is to put capital in the hands of people who may otherwise have trouble acquiring funding. By guaranteeing the loans, the SBA reduces some of the risk for banks which enables easier access to capital. SBA loans are often the first choice for new businesses who may lack the sufficient banking history and credit score to easily obtain a conventional bank loan.

In addition to the disaster loans, the SBA backs three other popular loan programs:

  • General Small Business Loans 7(a): This is the SBA’s most popular program. It provides eligible small businesses with the capital they need to either start their business, or expand into new products, services, and markets. These loans can be used for most business purposes, including operating costs and acquiring fixed assets (like equipment and real estate). The exact restrictions, amount, and terms will vary depending on the exact type of loan you receive, so make sure you work with your lender to understand the full requirements. You can learn more about the 7(a) loans on the SBA’s website.
  • Microloan Program: This program provides nonprofit community organizations with funds to benefit their local area. Those organizations then manage the funds and provide loans to small businesses, as well as certain nonprofit childcare centers. The loans can be up to $50,000 (average around $13,000), and can be used for working capital, inventory, supplies, furniture, fixtures, machinery, and equipment (they cannot be used to pay existing debts or purchase real estate). Repayment terms vary depending on the application. You can learn more information about microloans on the SBA’s website.
  • Real Estate & Equipment Loans CDC/504: The 504 loan is specifically designed to provide businesses with the capital they need to improve and modernize major fixed assets (like real estate and equipment). The goal of the program is to help with community economic development. The SBA provides funds to partnering Certified Development Companies, who then work with the SBA and local banks to provide the loans to small businesses. These funds may only be used to purchase buildings and land, make improvements to the buildings and land, modernize and renovate existing buildings, purchase machinery, or refinance debt that’s connected to previous expenses related to these fixed assets. You can learn more about the 504 Loan Program on the SBA’s website.

4. State-run loan programs

Many states also provide small businesses with loans and other financing options, similar to the SBA’s programs. For instance, in Virginia, the Virginia Small Business Financing Authority provides small businesses with a variety of loan funds, credit enhancement, and bond and grant programs. We recommend researching the resources your state makes available to you and speak with someone from the agency to see which may be a good fit for your business.

5. Other private sources of funding

In addition to disaster assistance and conventional loans, there are some non-traditional sources of funding that you should also consider:

  • Personal Loans: If you know someone who has the personal capital, you might consider asking them for a personal loan. Private investors are in the same situation as banks, and are looking for alternative sources to invest their money.
    If you know someone who is looking for a way to invest their money and are interested in receiving loan interest income, reach out to them. Ask them if they would be willing to help your business. If you are struggling, the people around you who care about you will want to know, especially if they are in a position to help.
    This isn’t recommended for everyone or for every relationship, but it can be a great way to give both parties a win-win situation. Make sure you work with an attorney so that you have an agreement and terms in place to protect both of you. It’s also a good idea to keep your personal lender closely informed about the state of your business finances.
  • Private investors, equity firms, and alternative P2P lending: There are many private institutions (like Kabbage, Lendio, etc.) who provide privately backed loans or investment. These arrangements vary widely and are at-your-own risk. Loans from these institutions also tend to have very high interest rates and restrictive terms (such as requiring weekly automatic payments, which can pose difficulty if you experience inconsistent cash flow).
  • Private grants: You may also want to look into grants sourced from private companies such as FedEx, Intuit, Walmart (for nonprofits), and Wells Fargo. Facebook and GoFundMe (in collaboration with Intuit and Yelp) have started grant programs specifically to help business through the pandemic.

Misconceptions About Business Financing

As we have helped others select and prepare to apply for funding, we’ve encountered many misconceptions about how business loans work. Here are the top two myths:

  • Federally guaranteed means I don’t have to pay the money back. No, the guarantee is for the bank not for you. A federally backed loan provides risk mitigation for the banks if you default on the loan and are unable to pay. After the bank has exhausted all options to recover their loss, the federal government will step in to buy back a portion of the loan.
  • I won’t owe any money if my business goes bankrupt.This only applies to businesses who were able to acquire a loan on the basis of its own credit and banking history. If your business does not fall into that category, you (and any co-owners) would have to personally guarantee the loan. This means you would still be responsible to pay off the loan even if your business filed for bankruptcy. The only way you would be able to get out of the loan is if you filed for personal bankruptcy, which could destroy your personal credit. Borrowing money is always a very serious matter with far-reaching implications that must be thought through, no matter how desperate you are.

    Additionally, the SBA specifies that you must put up collateral for loans of over $25,000, which can include your personal assets (such as a home or other real estate). Banks and others lenders may require similar assurances that you can personally pay off the loan, even if the business fails.

How to submit a stellar application:
Use the documents to tell a story

When you file any application for financing, you will encounter a massive amount of required documentation that you need to collect. While the information may be overwhelming, think of your loan application as a story. Your loan application is not just a mashup of random financial statistics. You are using all of the information and documentation to construct a narrative that tells them the story of your business and shows them that your business will be a good investment.

Each loan application differs in the information and forms that you need to fill out, so check with your lender for the specific documentation you need to prepare. However, this outline can give you a general idea of how each item fits into the narrative you’re providing:

  • FOR SBA DISASTER LOANS: Show how your business normally runs without the impact of the pandemic. You can give the SBA an accurate picture of your financial state by providing them with:
    • Your most recent Federal Tax Return,
    • Your 2019 Profit & Loss Statement,
    • Your current 2020 Year-to-Date Profit & Loss Statement,
    • Monthly sales figures from the three prior years, and
    • A financial forecast to illustrate what the income and expenses will be from now until normal operations resume. (The SBA does not require this, but will provide a more complete application).
  • FOR CONVENTIONAL AND PRIVATE FUNDING: Prove that your business is a sure investment. Lenders view their loans as investments: they give you money, you pay them interest on the money you give them. Whether it’s a federally or privately backed loan, every lender wants to know that their investment will pay off and you will be able to pay back the loan. That’s why banks have such rigorous banking history and credit requirements for loan applicants.
    In addition to running your financial history, there are two other documents you can prepare to show a lender that your business is a good investment:
    • A business plan: A business plan shows a lender exactly how you are planning to turn your vision into reality. It’s the document that tells them how you are defining your goals and the steps you plan to take to reach them. The more detailed and well-developed your business plan is, the more easily you will be able to show a lender that the risk of lending you money will pay off.
    • Financial projections: Financial projections forecast future revenue and expenses, which shows a lender whether or not the amount you are requesting is realistic. Detailed financial projections also let a lender know that you have a solid understanding of finances and what it really takes to run a business.
      If you already have an established business, financial projections are fairly simple because you already have a history of both your revenue and your expenses. However, if you have a relatively new business or if you’re branching into a new product, service, or market, financial projections are not as simple. You will need to conduct research to provide solid and realistic numbers for:
      • How you plan on turning a profit,
      • How you will price your products or services,
      • Cost of goods and services, and
      • Operating costs such as
        • Marketing budget,
        • Payroll expenses,
        • Licensing fees and taxes,
        • And all the other expenses it takes to run a business.
  • FOR ALL LOANS: Prove the stability of your personal financial situation. In the event that your business lacks the necessary financial history, you (and your co-business owners) will need to provide personal financial statements. These documents prove that someone will still be able to pay off the loan, in the event the business fails. You prove your solvency by giving your lender information about your assets and liabilities.
    • For assets, banks look at
      • All sources of income (salary, income from real estate, etc.),
      • Cash on hand and in bank accounts,
      • Savings accounts,
      • Retirement accounts,
      • Life insurance,
      • Stocks and bonds,
      • Real estate, and
      • Personal property, like cars, motorcycles, boats, and other assets.
    • For liabilities, banks look at
      • Mortgages,
      • Credit card debt,
      • Automobile loans,
      • Previous loans from banks or other sources,
      • Unpaid taxes,
      • Outstanding legal cases, and
      • All other debts and liabilities.

If you don’t know where to find any of this information, or if your current finances are not in a place to pull good reports, please reach out to us. We’ll help you sort everything out so you can start applying for financing faster.

Have questions? Please reach out!

While we are not certified loan agents or lenders, we have experience applying for business financing for both our own business and our clients’ businesses. We can help explain the process to you, introduce you to lenders and business advisers, and also help you prepare the documentation you need to tell your business’s story in your loan application. Please reach out to us if you have any questions!

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