Considering SBA Disaster Loans for your small business or startup?

SBA Disaster Loans might be a useful tool to help you weather this economic downturn — or make things worse for your business.

tl;dr: If an SBA loan meets your needs, you should probably apply —you don’t have to accept what they offer. But you should go into this eyes open, knowing the pros and cons, which is what this article is about.

These are extraordinarily challenging times for startup founders and small business owners. Cash flow is likely slowing down as the economy slows and the effects of COVID-19 drag on.

At first blush, applying for an SBA disaster loan, immediately, might seem like a no-brainer. A loan gives you optionality that you can use if you need it. And if you wait too long to get started, it might be too late. In my own businesses, I’ve used debt and loans (SBA and traditional) to grow and to weather stressful times, it can be a very useful tool.

Some advantages of SBA loans include:

• because the government backs the majority of the loan, banks are willing to loan you money they otherwise wouldn’t
• the interest rates are sometimes good, and often locked in for a long time
• you might not have any other options for short-term working capital

But it’s not a panacea. In fact, it can be downright terrifying.

Let’s go through a few things you should consider before accepting an SBA loan.

1. There might be better options coming soon.

There is pending federal legislation (as of 3/22/20) that is likely to pass soon that may offer business interruption loans with different and perhaps better terms, like forgiveness of payroll that you pay. For a business with labor cost as its primary expense, this could be a very big deal. Most likely you won’t be able to do both an SBA loan and this one, so it might be worth just waiting another week or so to see how that comes together. It is possible that money could come faster, too.

2. Collateral & personal guarantees are no joke.

You will need something to collateralize the loan against, usually your business assets, which you’re putting at risk by taking out this loan. But for many businesses, its assets will be insufficient to back the loan, and you will likely be personally guaranteeing it if you own 20% or more of the business. This means your personal assets — house, savings, retirement, etc — could be at risk of seizure if you default on the SBA loan. Think long and hard about this, it is not a trivial decision! You probably have your business separated from your personal assets in an LLC, S-Corp, or C-Corp. This explicitly crosses that boundary. In my experience, once you’ve crossed it, it’s hard to go back. On the one hand, this means your assets are going to be on the hook for a long, long time. On the other, once they’re pledged, well, you’re already in the deep end of the pool, and keeping them pledged that way gets less painful over time. To this day, I’ve got personal guarantees for some parts of businesses I own. But be aware of what that means! (And make sure your spouse knows and agrees, too — this is not the sort of decision you make in secret — it affects your whole family).

3. Debt might not be the right answer.

You should make sure that taking on debt makes sense in your context at all. If your business was barely making ends meet before, saddling the business with debt is probably not a real answer to anything and probably makes everything worse. Model these cash flows in your financial model using varying assumptions for how your business will come back. What happens if we’re still quarantined in June? July? August? Later? What happens if business never comes back at the prior monthly rate? You need to consider all options, and let the math drive this decision, not fear.

(NewBoCo is partnering with Mike Colwell of the Greater Des Moines Partnership on virtual financial modelling seminar coming up this Tuesday, March 24, 2020, you can sign up here)

4. It might take too long to clear.

The SBA money will likely take at least a few weeks, and perhaps months, to show up in your account. Is it still worthwhile if it comes in 60 or 90 days? Perhaps this will be mostly over by then. Perhaps it will just be the beginning, and this loan won’t matter in the big scheme of things. It’s very hard to say. But it’s definitely not a quick fix.

The Iowa SBA is holding a webinar on some of the details of applying for these loans on Weds March 25 at 3:30. More info here: https://www.facebook.com/events/224836355375818/

5. Other, faster options.

Do you have other ways to get working capital — a home equity loan, a friends & family investment — that you could get more quickly, with the same or less risk?

6. You’re in hock to a bank, and no bank is your friend.

While you probably have a bank you like, at the end of the day, you’re one of many customers they might have, and subject to their whims in a way you might not understand. In 2008, my company took on significant debt similar to an SBA loan via a locally owned bank (not my current one). When the crash happened and the Fed started tightening the rules on banks, about a year later that bank attempted to call that loan even though we had performed according to the loan terms and nothing material had changed — they just wanted me off their books to meet Federal targets! This was at the height of the Great Recession; being forced to find another bank to take on our loan was really hard to do. It almost sank my business! While there are probably better and worse banks to work with, you can’t know in advance how situations will change. If you accept money from a bank (with the SBA backing it or not) that bank has significant control over your business. Just be careful.

An SBA loan might be the only and best — if risky — way to get working capital to help weather these turbulent times. But you need to go into this with a level head and clear thinking to decide if it is right for you. I hope these thoughts were useful in your decision-making process.

Eric

A tip o’ the hat to Jo Eckert and Scott Swenson for additions and clarifications.