Over the weekend, I read a LinkedIn discussion written by a frustrated owner of a small business. In his discussion, he mentioned his company is developing technology that will save small and mid-size businesses millions of dollars, yet he can’t get a loan from the SBA.
As I read his discussion I learned his project or service (he wasn’t specific) was pre-revenue. His company is young and technology oriented.
The business owner is very frustrated. He linked the lack of bank and SBA loans to his company’s problems financing the process of bringing his product to market and generating revenues.
The writer is not alone in his misunderstandings of debt, equity, and the funding of a startup company. Here are a few things business owners in similar circumstances should know:
- The SBA has a micro-loan program that might be suitable for this company, but its current limit is $35,000. (Congress is considering raising this amount to $50,000). Microloans are made based on the creditworthiness of the business owner and the viability of a business plan. Many micro-lenders will make loans when a company is just rolling its product into the market.
- The SBA 7(a) program which the writer of the LinkedIN group was writing about is the SBA’s flagship loan product for companies that have enough revenues and EBITDA to repay the loan.
- Any bank loan including SBA 7(a) loans are made to businesses that can demonstrate their ability to repay their debt. In general, a business must show that it has 1.25 times more cash coming in to service its debt than the debt it will take on plus existing debt. This ratio is called debt service coverage ratio (DSCR).
- No bank nor the SBA is in the business of loaning money to businesses that cannot show their ability to repay their loan. A pre-revenue company doesn’t have a track record that shows its ability to repay the loan. Many SBA and other bank lenders want to see two years of profitability before they will lend money.
- While debt service is critical to any loan, there must also be acceptable collateral for a lender to use to secure their loan. Many pre-revenue high-tech companies don’t have real estate or significant equipment that can be used as collateral for a significant loan. The purpose of the collateral is provide a backup source of repayment in the event revenues are not sufficient. Patents, trademarks, and other intellectual property are generally not considered.
Debt is not normally a suitable form of financing for a pre-revenue company. The SBA programs are simply not set up for banks and the SBA to take that kind of risk.
For the company whose owner complained on the discussion group about SBA lending programs, obtaining financing through personal resources, friends and family, and angel investors is the most likely source for financing. Equity financing can occur in many different forms, but if the above mentioned company really has a “platinum” product to save small and mid-sized companies, it should be able to secure equity financing.