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Response #1:
At 09:31 AM 1/30/2007, SBA-preferred lender wrote:
Al,
That was a great article on the SBA process but there are a couple of misconceptions
I will like to clarify. First, SBA loans typically range from 7 to 25 years
and have higher rates than their conventional counterpart and that is because
these loans typically carry a larger credit risk if not the borrower would
have gone conventional and because the term is much longer and the term
in itself is a risk. Since the longer term allows for economic slowdown,
change in competitor market and other factors that can affect the borrower's
ability to repay. The advantage is the term for you will never see a conventional
bank loan given for 7 years for working capital or 10 years for machinery
and equipment. Hence, the borrower's monthly payment will be lower and will
help a startup, growing business or a business that without the longer term
will not be able to purchase the asset needed to expand the business.
The other misconception
is that these loans are risk-free to the lender. At one time it was, but
that led to banks being very lenient in their credit policy and lending
money to any business applying through the SBA loan. As you can imagine,
the loan losses to the SBA grew tremendously (which is covered by taxpayers'
money) and they started enforcing a more reasonable credit requirement.
From this came the 85%, 75% and 50% SBA guarantee and therefore the SBA
does not guarantee the loan 100%. Now on a small loan, a 25% risk by the
lender might not seem like a big deal but on a $1MM it means a $250M risk
and on a $2MM is a half million risk. To mitigate the risk to the SBA and
the lender, the SBA requires the lender to take all available collateral
first from the business and then from the principal owner, who owns 20%
or more, until the loan is secured 1:1. If this wasn't the case, than the
business owner who let his business go into bankruptcy can walk away from
the venture w/o any loss to him/her while we the taxpayers cover his default.
So, it is not that a home is preferred but is that most businesses do not
have sufficient assets to secure the loan, the case in almost all startups,
and the most likely asset the principal owner has is his/her home. If they
have another asset such as a CD or marketable securities that will mitigate
the collateral risk than the lender will likely use that than the home because
it makes the transaction much simpler to close. Last misconception, we do
not use the owner's automobile as collateral :)
Sincerely,
SBA-preferred lender
Response #2:
At 10:00 AM 1/30/2007, SBA-preferred lender wrote:
I am sorry Al, you are a good guy but I have to extremely disagree with your comment that entrepreneurs use their credit cards to fund the startup. That is probably the worst mistake they can make. First, the payments on the credit cards will be ridiculous. Second, and more importantly, a person's FICO score is determined by his/her usage of their revolving credit including their revolving availability. In best case scenario, an individual should not be using more than 30% of their credit limit but when you use your credit cards to fund a startup this percentage will jump up dramatically and your minimum monthly payments will also increase tremendously. Typically, the hardest time for a new business is the first couple of months when cash flow is tight you and now it is compounded by the significant monthly credit card payments and that is a recipe for disaster. At this point, the business owner approaches the bank for an SBA loan and his/her FICO score looks horrible due to maxing out the credit limit, high monthly payments, and maybe some late payments because of cash flow problems and the bank will likely reject them. I see this scenario all the time and extremely advice against it.
-----Original Message-----
From: Al Berrios
Sent: Wednesday, January 31, 2007 11:18 AM
To: SBA-preferred Lender
Subject: Re: Credit Cards?
I did it with credit cards and if I had to do it again, it'd do it again. There was just no other way for someone in my line of business to fund his vision since I started right out of school with no assets or experience.
What you're forgetting is that the unsecured nature of revolving credit IS the benefit, since I can declare bankruptcy at any time without losing the shirt off my back, despite these new rules that supposedly make it harder to declare bankruptcy. (If I'm broke, I'd like to see MBNA claim I can still pay my bills.. HA!) And thanks to intense competition among credit card companies, I'll be extended fresh credit in no time flat.
Sure the payments get higher with more money you take, and cashflow is always a challenge, but the tactic isn't exclusively to use credit as operating cash, but also take the credit as a cash withraw to deposit in a bank and use a collateral for a good loan, from which those pesky payments can be made. (And besides, not every business has fixed overhead which can endanger cashflow...)
And who cares about FICO anyway?! I only care about FICO scores if I want to get a conforming loan... there's still non-confirming loans out there for the person who knows how to play the borrowing game. And we both know that there are plenty of companies out there handing out money as though it were confetti, including divisions of some of the biggest financial institutions on the planet.
I'm not presenting a credit card strategy for everyone, but merely an alternative for most disciplined entrepreneur (that's why we publish our disclaimer: http://www.alberrios.com/c/about/disclaimer.html.)
You're probably thinking I'm crazier than you thought :) , but your email reminds me of [two] little incident[s] I once had with an insurance broker and another insurance industry consultant I know. Both actually turned red in the face as I explained to them my rationale for not needing their insurance products. They then proceeded to yell at me as if I had just insulted their grandmothers. Since then, it has never ceased to amaze me how utterly ingrained the "established" way of doing things is that when someone suggests an alternative course of action completely going against the establishment, there's always defenders for the establishment.
.al
P.S. I'm doubly impressed at your passion for this business...
Everytime I publish something about banking, money, anything, you're always the first to respond... Considering how many lousy experiences I've had with every sort of financial institution, I'm surprised you haven't taken my articles as signals of the latent opportunities for someone like you to do something about the way things work for "disadvantaged" borrowers.
P.P.S. Did you read about my experience with Dell Financial Services: http://www.alberrios.com/c/0605cpg.html.
At 12:22 PM 1/31/2007, SBA-preferred lender wrote:
Ok, with some service
based businesses that do not need to purchase substantial FF&E or do
some leasehold improvements I will agree. But that is a very small percentage
of most businesses. Businesses like food franchises, restaurants, Laundromat,
manufacturers, distributors, retailers, doctors, chiropractors, dentists
and many other businesses will incur a substantial amount of M&E, leasehold
improvements, inventory, furniture & fixtures, 3 to 6 month rent security
deposits (IN MANHATTAN) and other operating expenses prior to opening. This
requires a substantial amount of capital of at least $150M and I don't think
many entrepreneurs have that amount in credit limit. "Take the credit
as a cash withdraw to deposit in a bank and use as collateral for a good
loan", that doesn't make sense. So the borrower is going to incur interest
from his credit card and the bank for the same money. Let's see 21.60% interest
from the credit card and another 10% from the lender, that sounds like loan
shark rate to me. Oh, but I forgot it is offset by the great 5% he/she get
from the savings/ CD account.
FICO scores are important since its is proven you will pay more interest
for lower FICO scores and yes there are alternative lenders out there but
find me one that will finance the build out of a startup or provide working
capital to a startup, or finance the inventory of a startup. Most alternative
lenders will either factor your receivables, finance them, lease equipment,
purchase equipment, finance furniture, but I haven't seen one that will
give you $100M for construction cost on a new retail space. If there is
one, I guarantee you will pay more with them and get a shorter term than
with an SBA loan. On top of that, they will hit you with prepayment penalties
and the great "balloon payment". Here is a scenario; a business
owner finances his newly established business through personal credit cards
and an alternative lender with a balloon payment of $100M in two years.
Now, because of the credit scenario I mentioned before, his FICO score has
decreased and the two years are up and he has to make that balloon payment.
Well, good luck trying to get the note refinanced before the balloon payment
or let me know how it feels to pay 5% prepayment penalty on $100M.
Are SBA loans for everyone? NO, but it was meant to be for everyone. The
fact is that it helps startups get financing and other companies that do
not qualify for a conventional loan.
Anyway, just the Latino in me, you know how it is, we like to debate.
-----Original Message-----
From: Al Berrios
Sent: Wednesday, January 31, 2007 1:29 PM
To: SBA-preferred Lender
Subject: RE: Credit Cards?
LOL! I love it!!! Nothing's more stimulating to me either than a good debate. (I'm very glad you didn't get mad at my last email, too. Phew!)
Anyway, on to my rebuttal:
It's a known fact that at least 60% of the U.S. economy is driven by service businesses, which is what I was going by. But now that you bring up that even doctors and restaurants, both service businesses, require financing for hard assets, I went back to take a look at the files of the entrepreneurs I've counseled and documented, and am surprised to see that about 2/3 definitely need financing like you say here to get started. So, OK.
But to clarify, from the outset, my perspective is that no matter where you get money from, it'll cost you: whether VCs, investors, or banks. So, I always see it as a cost that, like taxes and insurance, MUST be factored into a business plan. So, based on a thorough analysis, if the entrepreneur understands every single expense and potential risk, but they're still projecting income from operations, enough to live off of AND pay everything they owe, based on demographics of targeted audience, pricing, and managing variable costs better, then a theoretical 30% fee and any pre-payment penalty for borrowing money shouldn't be such a big deal. Especially since by the end of year 1 or 2, this can be refinanced for better rates, while simultaneously unsecuring important assets, and protecting them within legal structures and things like credit-protector insurance.
The problem I'm addressing isn't the cost of capital, but rather GETTING capital, especially to finance 100% build-outs without those balloon payments or pre-payment penalties, (which angry entrepreneurs can tie up in lobbying for months or years if they report these tactics to over-zealous attorney generals in their cities/states).
In fact, it's precisely because so many conditions exist in order to "qualify" to just get the money to launch a business that I'm bringing to light alternatives on playing around with financiers... it's like applying for a good job - no one wants to hire you without experience, but how can you get experience without a job? It's the same catch-22 in getting money, too.
But not with credit cards who'll gladly give anyone, even inexperienced college kids, money. So if these organizations knowingly take advantage of consumer ignorance, why shouldn't a consumer prepared to exploit these companies, even at 30% interest for a year, not do the same? (Credit cards even offer to consolidate debt on other cards at 0% interest for months at a time, so the likelihood of actually getting a 21.6% APR are slim for the right candidate!)
Furthermore, in another analysis I did, to my shock, I discovered that over 85% of all of the public companies in NYC are "money-changers" like banks and other financial institutions, with the rest being actual businesses like restaurants and manufacturers. The most obvious revelation is that there's a substantial dearth of creativity and ideas for money-making businesses, which means that those 85% of money-changers are desperate for ideas.
Thus, as I see the world, it's a bunch of unimaginative rich guys tripping over each other to finance ANYONE with an idea at the least possible risk to them and their money, never mind that the entrepreneur is the one that actually has to DO the work in addition to coming up with an idea.
So, honestly, the argument I'm supposed to buy from financiers is that if I fail as an entrepreneur, I'll lose my home and 2-4 years of my life (and corresponding earning potential doing anything else, a cumulative opportunity cost easily worth over 100% of any value of any business), but the financier loses considerably less because they keep my assets and have some of their risk guaranteed by the taxpayer? Oh, and they don't have to start looking for a new job to pay their bills right after I fail. If that's not an obvious exploitation of ignorant entrepreneurs, what is?
And you're right, I'm not knocking the intentions nor the successes of the SBA. Merely offering another perspective on how it can be utilized by an informed entrepreneur.
Can I publish our emails... I think they're great!
.al
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