The article starts with a question from the owner of a medical technology firm that couldn't get a bank loan, despite one million patients and $2 to $3 million in annual revenue. After being rejected for a working capital SBA loan three times, he started trying to convince his wife to put the house up as collateral. According to the Small Business Administration, participating lenders must secure collateral from principal borrowers that add up to the amount of the loan. Unfortunately his is a hard and fast rule that has been adopted as "law" to the SBA. The current SBA program guidelines require the lender to require the borrower to pledge all 'worthwhile' collateral until the loan is fully secured on a liquidation-value basis, which includes personal assets, such as the borrower's home.
Why does the SBA require so much collateral?
In lieu of collateral, the only thing that banks can use is income to gauge your ability to repay the loan. This means if your loan is unsecured, you must meet other qualifying criteria, such as the demonstrated ability to repay the loan within the agreed-upon timeframe.
Another reason for all the safeguards is this – the SBA loan is very highly leveraged and offers long-term stable amortization, which requires the borrower to pledge other available collateral to fill up the shortfall. In most cases this requires the use of personal assets. Business borrowers may want to change it, but this collateral policy has been place for years and it has done a lot to minimize credit loss. The term for these loans is usually five years or fewer because so many businesses, unlike personal real estate, because business assets are short-term in nature. Over the long term, the SBA cannot guarantee the lender will have the recovery value necessary in the event of default.
According to many credit officers, the willingness of a borrower to put their personal assets on the line shows their commitment to the success of the business and the repayment of the loan. In the event of a default, the government is on the line for up to 75 percent of a loan's value, so why wouldn't they expect the borrower to put his or her house on the line? It makes sense that they'd only want to take the risk with someone who's "all in."
As uncomfortable as it may be to sign the papers that put your home in jeopardy, until recently there weren't many other options. Overall, all forms of alternative lending tends to be two to five times more expensive than an SBA loan, which are still tied to the market's relatively low interest rates.
One option is to get personal guarantee insurance, which makes it much less scary to sign over the house. Another is to court private investors, such as venture capitalists that specialize in your area of business. Some entrepreneurs look to wealthy family members as a source of alternative funding, but this is rarely the best way to find larger sums of money.
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