April 3 2019

Understanding the options for financing your business


When an entrepreneur is first considering purchasing a business or franchise, various financing options are usually considered, and the most appropriate financing product(s) should be selected. For example, an equipment lease is often chosen for financing new equipment needed to run the business. Another option is to finance the entire business with an SBA 7(a) loan. A third option is to self-fund using funds saved in the entrepreneur’s retirement account using the R.O.B.S. program established by the IRS.

It is very unusual when two financing products are complementary and can be selected jointly to finance a new business. With the introduction of the SBA Express loan, this is no longer the case. An SBA Express loan complements an equipment lease for financing a new business and the expansion of an existing business.

In 2014, the Small Business Administration (SBA) introduced the Small Loan Advantage loan program some lenders refer to as the SBA Express loan. After the “The Great Recession,” many homeowners lost their real estate equity which is used as collateral requirement for a SBA 7(a) loan approval in most cases. Consequently, many perspective borrowers were unable to secure financing because they lacked the equity in their home required to collateralize their loan request. The SBA Express loan caps the loan amount at $150,000 to limit the lender’s risk since the borrower’s real estate collateral is not required. Instead, the business assets are used to collateralize the SBA Express loan and the main approval requirements are good personal credit and some liquid assets.

Since the collateral used to secure an equipment lease is the equipment being financed and the collateral for the SBA Express loan is the other business assets, these two debt financing products are totally compatible. Furthermore, since the underlying concept of the SBA Express loan is to provide working capital, financing the equipment needed to run the business provides the owner more working capital so the underlying reason for both products is the same.

Capital leases – leasing equipment-to-own

The most common financing option available for businesses using equipment leasing is a capital lease. The main purpose of a capital lease is to finance the equipment purchase while preserving the owner’s working capital. Business owners can finance the purchase of their proprietary equipment, security systems, computer hardware and software, flooring, outdoor signage and other tangible items needed to run the business using an equipment lease. The owner(s) will be required to personally guarantee the equipment lease unless the business has been established and profitable over many years.

The required down payment ranges from one lease payment up to 20% of the amount financed. Lease documentation fees may range from $95 to $495. Repayment terms typically range from 12 to 60 months. All payments made are tax deductible so the payments will lower the business’s taxable income and, in turn, tax liability. Since most owners plan to keep their equipment long term, a typical capital lease offers a $1 end-of-term purchase option. In short, an equipment lease is used to finance the purchase of all equipment needed to manage the business, thus preserving working capital.

Small Business Administration (SBA) Express working capital loan

This government-backed loan is designed to provide working capital ranging from $20,000 up to $150,000 for start-ups and existing businesses. The main purpose of this loan is to provide the funds necessary to support the company until the business generates positive cash flow. The loan process takes 60 to 90 days to complete on average before the loan is funded. The SBA loan process does require an attention to detail to complete the application and contingency requirements. If the use of the loan funds is to finance a new location, the loan can be approved in advance, however the funds will not be distributed by the bank until the new location has received a certificate of occupancy. This ensures that the money will be used to operate the new business and will not be used to pay for build-out expenses.

The interest rate for this loan is calculated by starting with the prime rate as published in the Wall Street Journal. The bank then charges a 2.75% risk premium on this loan. This is a variable rate loan which changes quarterly when the Fed Board of Governors decides to raise or lower the prime rate. The repayment term is 10 years and there is no pre-payment penalty so if the business owner is extremely profitable, the loan can be prepaid to save interest expense.

The purpose of using SBA loans and equipment leases is to access other people’s money (OPM) and preserve capital. The goal is to borrow the money at a cost that is less than the business profit percentage. For example, if a $100,000 equipment lease provides a 12% return to the lessor and an $150,000 SBA working capital loan has a 6.5% interest rate, the business owners will be borrowing $250,000 at approximately an 8.9% blended interest rate. Assuming the business operates at a 15% profit margin, the franchisee is using OPM at a cost that is much less than the anticipated return on capital.

Equipment leases and SBA Express loans are complementary products that will enable an entrepreneur with good personal credit to finance the opening and expansion of a business. The best part about this financing combination of an SBA Express loan and equipment lease is that the collateral is your business assets -- not your home -- just your business assets!