I wrote recently about the basic SBA programs for financing business acquisitions. That prompted the following email from a reader:
I’ve always struggled with the SBA stuff. I have come to assume start-up money is non-existent from the SBA? I’m a computer guy with a background in fitness and have looked at starting a gym, but the capital demands always thwart the idea.
Unfortunately, start up money is just about non-existent from the SBA. The reason is that the SBA doesn’t actually loan the money, they just guarantee a portion of the loan that a lender (usually a bank) makes. So the lender is still at risk for the un-guaranteed portion, and they are going to be very conservative about making a loan.
Look at it this way. A bank makes about 10% interest on the loans. With points, commissions, etc., it is less. I don’t know what their cost of money is, but the point is they really don’t make that much money on each loan. They need to make a number of loans to make decent money, and it doesn’t take many bad loans to bring the profit down to zero. It happens. So they need to be very careful, which they are.
It is all about the risks and the rewards. You’ve probably heard the oft-repeated stats that 8 out of 10 business startups are not around in five years? Well, that isn’t true. The SBA did a study and found it is more like 4 or 5 businesses, but that still isn’t very good so the banks are not crazy about loaning money for these startups.
As a reference, venture capitalists target 50% return on investment, purely because of the startup risks. They KNOW that many of their investments will fail. Private Equity Groups typically invest in established companies, and they target around 35% return on investment. So you can see that bank that makes less than 10% is not going to want to take any risks. They can’t.
How to take away some of the risk to the bank so they will consider a loan to you?
Franchises are one way, as they tend to have a better startup record than independents. However in this tough economy there are challenges there as well. See the latest post on franchise financing (and the link contained there).
The other ways are pretty obvious because the bank will press these on you anyway. Putting your home up as collateral, personal guarantees, high down payment, etc. Basically, the old adage isn’t far off: if you can prove you don’t need the loan, then you’ll qualify for one. I wish it were different, but it isn’t.