When obtaining a commercial loan from your bank, your banker may tell you that SBA guaranteed loans are the best thing for your situation. And they may be…but be careful, because they come with many restrictions and hidden dangers. However, by carefully negotiating the terms, and structuring your personal assets appropriately, you can minimize the risks.
First, let’s explore what the SBA guarantee means. Simply put, it means that if you default on the loan, the SBA will step in and reimburse the BANK, not you, for any deficiency after your assets have been liquidated. And this guarantee, which protects the bank, is why banks are eager to make these types of loans. However, these loans have drawbacks and pitfalls. Specifically:
- Fees of 3% are typical: Basically you, the borrower, are paying for the bank’s guarantee up front in the form of a 3% fee.
- Personal guarantee: By definition, all SBA backed loans have personal guarantees.
- Lack of flexibility: If you ever get into trouble, and need the bank to be flexible on the terms of the note (interest rate, term, etc.), you will find that the bank has limited ability to work with you. This is because of SBA regulations, not because the bank doesn’t want to help.
So what can you do if the bank is insisting that an SBA loan is the only option for you? There are several simple things you can do that will critical down the road if things ever get sticky.
- Limit the guarantors to just yourself. Do not agree to add guarantors or co-signers to the loan documents. The bank will want your wife to sign. Tell them she refuses. The bank may want another family member to sign, or may ask for “limited” personal guarantee. Say no thanks…but tell them that you still want the loan.
- Transfer your personal assets into another family members name BEFORE you take the loan and sign a personal guarantee. This will effectively keep them out of harms way in case of a default.
- Apply to multiple banks, and keep looking until you find one that is willing to accept these terms.
By taking these simple steps, you can provide yourself with tremendous flexibility in the case that your business fails or is placed in the Bank Workout program. By limiting the your exposure to the personal guarantees, you provide yourself with a viable alternative in the case of difficulties.
Bottom line: SBA loans play a critical role in helping small business owners get started, but they have drawbacks as well. Be careful and protect yourself.