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How Commercial Lenders Went Wrong With Small Business Financing
February 17, 2011 | 
Author Small business owners will be more likely to avoid serious future business finance problems with working capital management and commercial real estate loans by exploring what went wrong with business financing and commercial lending. This is not a hypothetical issue for most commercial borrowers, particularly if they need help with determining practical small business financing choices that are available to them. The bankers and banks responsible for the recent financial meltdown seem to be saying that even if anything actually went wrong, everything is fine now in the world of commercial lending. Nothing could be further from the truth. Commercial lenders made serious mistakes, and according to a popular phrase, if business lenders and business owners forget these mistakes, they are doomed to repeat them in the future.
Greed seems to be a common theme for several of the most serious business finance mistakes made by many lending institutions. Unsurprising negative results were produced by the attempt to produce quick profits and higher-than-normal returns. The bankers themselves seem to be the only ones surprised by the devastating losses that they produced. The largest small business lender in the United States (CIT Group) declared bankruptcy after two years of attempting to get someone else to pay for their mistakes. We are already seeing a record level of bank failures, and by most accounts many of the largest banks should have been allowed to fail but were instead supported by artificial government funding.
When making loans or buying securities such as those now referred to as toxic assets, there were many instances in which banks failed to look at cash flow. For some small business finance programs, a stated income commercial loan underwriting process was used in which commercial borrower tax returns were not even requested or reviewed. One of the most prominent business lenders aggressively using this approach was Lehman Brothers (which filed for bankruptcy due to a number of questionable financial dealings).
Bankers obsessed with generating quick profits frequently lost sight of a basic investment principle that asset valuations can decrease quickly and do not always increase. Many business loans were finalized in which the commercial borrower had little or no equity at risk. Banks invested almost nothing in cash (as little as three cents on the dollar) when buying future toxic assets. The apparent assumption was that if any downward fluctuation in value occurred, it would be a token three to five percent. In fact we have now seen many commercial real estate values decrease by 40 to 50 percent during the past two years. Commercial real estate is proving to be the next toxic asset on their balance sheets for the many banks which made the original commercial mortgages on such business properties. While there were huge government bailouts to banks which have toxic assets based on residential mortgages, it is not likely that banks will receive financial assistance to cover commercial real estate loan losses. As a result, a realistic expectation is that such commercial finance losses could produce serious problems for many banks and other lenders over the next several years. As noted in the following paragraph, many lenders have already drastically reduced their small business finance programs.
Inaccurate and misleading statements by commercial lenders about their lending activities for business finance programs to small business owners is an ongoing problem. Although banks have typically been reporting that they are lending normally with their small business financing, the actual results indicate something very different by any objective standard. It is obvious that lenders would rather not admit publicly that they are not lending normally because of the negative public relations impact this would cause. Business owners will need to be skeptical and cautious in their efforts to secure small business financing because of this particular issue alone.
There are practical and realistic small business finance solutions available to business owners in spite of the inappropriate commercial lending practices just described. The emphasis here is focusing on the problems rather than the solutions primarily because of the lingering notion by some that there are not significant current commercial lending problems. Despite contrary views from bankers and politicians, collectively most observers would agree that the multiple mistakes made by banks and other commercial lenders were serious and are likely to have long-lasting effects for commercial borrowers.
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Small Business Finance
If you are a small business person then it is very necessary for you that the business does not ever lacks in funds or it may stop functioning any time. Small business finance is carved out specifically for providing timely finance to small business people and the loan is approved at competitive interest rate. This ensures that the loan is not a financial burden on small business. You can meet all business expenses like buying raw material, equipments, paying salaries or clearing past dues etc through the loan. but you should be well versed in the loan to take it in a better way.
Small business finance come in secured or unsecured options. Secured business finance is meant for meeting greater loan requirement of your business. You can pledge your home or any commercial property as collateral of the loan. Secured business finance also is preferred for its lower interest rate. The loan also can be conveniently paid back in 25 to30 years or earlier as suits to your circumstances. Secured business finance is also best suited to bad credit business people as their property enables them to take the loan despite credit problems.
Unsecured small business finance are risk free loans for business people as lenders approve it without collateral. But you get only smaller loan and it has to be paid back in shorter duration. Also you would be paying interest at higher rate. Usually good credit business people are made unsecured small business finance. However, bad credit business people are also eligible if they have a convincing repayment plan in place that shows that they run a profitable business.
Whether you take secured or unsecured small business finance, the lender will first of all take a deep look into your type of business and will approve the finance only if he finds your business prospects bright. This necessitates for a convincing the lender about your future business plan and that the loan will be invested in a beneficial way.
Small business finance can be sourced from banks or financial companies. But online lenders are considered as best source of lower rate finance for any business. So better apply to an online lender. Before that, compare all lenders for rates to find a suitable offer.
Tips for Ensuring Small Business Finance
Are you looking for smaller monetary support for running your business? Surely such finance goes a long way in smooth functioning of the business, provided it comes in time and without any hurdles posed by the lenders. You can opt for small business finance to support your business. At the same time you must be well versed on key aspects of the finance to avail it beneficially. Small business finance is especially designed to provide finance to small scale businesses.
Prior to applying for small business finance, you must do your home work regarding the finance and business. First of all keep your entire business record like past tax records, bank statements, balance sheet etc in place and ready to show them to the lender. Secondly, as you would be spending the finance into the business, the lender would like to see your ability to repay the loan. The lender will see the capacity of your business to generate income shortly so that you can repay the loan in time. You must have a convincing repayment plan.
If you want to borrow greater amount then the lender will ask you to pledge a property, residential or commercial, as collateral. Secured small business finance is source of greater loan depending on collateral value. Also, the finance comes at lower interest rate. You can repay small business finance in 5 to 30 years. Low rate and larger repayment duration thus makes the finance less burden some to pay back.
In case of smaller requirement, you can then opt for unsecured small business finance which is approved without collateral. You would be given smaller finance for shorter repayment duration ranging 5 to 15 years. Interest rate on unsecured small business finance goes higher.
Even if your credit history is less than perfect, there are host of lenders providing small business finance to bad credit business people if they can prove repaying ability. Late payments, arrears, payment defaults, CCJs and IVAs do not usually come in the way of loan approval.
Online lenders give you small business finance at lower rate of interest compared to banks and financial institutions. Have rate quotes of online lenders to find suitable loan offer.
Tips For Small Business Success in 2010
Don’t Take Notes From Big Business Are your marketing efforts not yielding results justifying the investment? Before you react, consider your view of marketing itself.
I’ve found a tendency for small business owners to consider marketing in the way big businesses practice it. To illustrate the point, think of five advertisements. Now, compare your marketing budget to theirs. Do they compare?
Celebrity endorsements, television commercials and billboard ads are expressions of marketing that typically come to mind. It’s natural. We’re a product of our environment and we’re constantly saturated with corporate messaging.
How businesses have marketed over the past 80 years is a result of mass production. Large-scale output led to mass marketing and created mass media. Like its products, companies found that packaging and delivering marketing content was also an efficient business practice.
Businesses wanted their messages to be seen by the most people possible. The bigger, the better philosophy worked because demand exceeded supply. “Market” evolved into a verb. It became something that producers did to customers.
Return to the Marketplace To reevaluate your view of marketing, consider an original practice. Marketing began hundreds of years ago as literally going to a marketplace to sell a good. Craftsmen would engage buyers face to face. He encouraged conversations and built relationships in order to sell his product. His craft became an extension of him. “Market” was something done with customers.
For small businesses to succeed in 2010, you’ll need to return to the marketplace. Rather than setup a booth at a flea market, try to give customers what they want. Not just with your product or service, but in your marketing.
I can’t think of someone who demands more adverting but everyone appreciates a good conversation. Conversations engage us in a powerful way. They contribute to partnerships, inspire ideas, make us laugh and may even cause you to sell something.
Determining the best place to start your conversation will depend on your product or service. Start by investigating options to market online. Consider social media networks as an opportunity to allow you to convey your unique voice. Like the old marketplace, encouraging a conversation will build relationships. Not only is it more personal, it’s more effective.
Continue to Invest in Your Business When some small business owners feel the pinch, they react by drastically reducing their marketing budgets. However, continuing to invest in your business is especially important during a downturn.
Competition actually increases during a recession. As many talented people are laid off, they substitute their time by innovating and opening businesses of their own. The Internet itself is also increasing competition. For example, Esty is a website that allows individuals to sell goods without having to operate a business of their own.
As consumers become more conscious of the dollars they spend, they more thoroughly evaluate potential purchase decisions. Consumer review and price comparison websites keep today’s consumer well informed.
Facing increased competition is not a time to lay-low. Smart marketers know that their efforts create long-term friendships. When we emerge from the recession, the value of continually maintaining friendships will be realized. If your business isn’t proactive, your competition could recruit the majority of post-recession friends!
Continue to invest into your business. If you’re marketing efforts haven’t achieved the results you desired, re-think your strategy. Consider relying on a professional or hiring a consultant to advise potential strategies.
Stop considering yourself as a company. This may seem counter intuitive. As a small business owner you wear many hats, from accountant to supervisor. The next time you put on your marketing hat, stop thinking of yourself as a company.
People don’t particularly like companies. Companies want to sell us on something. They use automated phone systems that keep us from a human being for as long as possible. They charge us too much for coffee.
The challenge isn’t to convince people to like your company. That’s a difficult fight to win. Instead focus on the associations people have with your company. What does your product or service mean to them?
To help realize your potential in 2010, consider your business’ identity in the minds of your customer. It’s how they define you that really matters.
Take Calculated Risks People like to stick to what they know. We are creatures of habit and tend to fear change. But, if you completely eliminate risks, you also eliminate the opportunity to grow.
It’s a new era in business. We have new challenges that require new solutions. Perhaps you have refrained from new opportunities to market your business fearing they won’t match with your customers. But consider the importance of reaching and influencing existing customers. Yes, frequent customers make up a significant portion of your sales but frequent customers aren’t synonymous with loyal customers.
Consider marketing less-popular products or services to target lower-volume customers as they represent the greatest growth potential. Small businesses are more nimble than the big guys. If you try something new and it doesn’t work out, you can more quickly change your strategy. You don’t face long negotiation processes, there’s no red tape and minimal office politics stand in your way.
There is uncharted territory to be covered along with new successes to be realized. Maintaining complete control is a losing game in today’s market place. Instead take a managed risk. Just start small. Until you venture to try something new, you won’t know your business’ full potential.
Re-Define Failure We have come to a universal understanding that failure is a bad thing and should be avoided at all costs. You’ve heard the phrase, “happiness is a state of mind,” but consider that failure, too, can be a state of mind.
Failing can actually make us smarter. There is great value in learning from our mistakes. If we apply an understanding of what went wrong to future efforts we can improve their effectiveness.
Re-think your definition of failure. Even if an effort doesn’t achieve your initial goals, don’t jump to classifying your efforts as a failure. You may actually uncover success in your failure in the form of information. Apply what you learned to improve the effectiveness of your next initiative.
Just as there are new challenges for 2010, there are new opportunities. Technology has gifted business owners with thousands of new opportunities to reach customers. Unfortunately, new technologies are frequently avoided. We don’t always understand them and they have yet to be “prove” their effectiveness.
The truth is that you don’t have to be a technological expert to employ all these new technologies. Many innovations are so user-friendly; they don’t require hiring an expert. Regardless of how your business uses technology, the role of technology in your customer’s life is increasing in importance.
Once we realize that failure doesn’t have to be a disheartening blow to your ego or bank account, we can begin to plan on failure. Accounting for failure reduces the risk involved with failing and establishes a system for future successes.
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New Tax Incentives in the Small Business Jobs Act of 2010
resident Obama signed into law the Small Business Jobs Act of 2010 (H.R. 5297, the “Act”) on September 27, 2010. The Act includes a $12 billion tax incentive package aimed at small businesses to help them grow and to expand lending. These tax incentives are offset by several revenue-raising provisions, as discussed in more detail below.
Provisions Providing Small Business Access to Capital
Temporary 100 Percent Gain Exclusion on the Sale of Certain Small Business Stock
In general, non-corporate taxpayers may exclude 50 percent of any gain from the sale or exchange of qualified small business stock
(“QSBS”) held for more than 5 years (75 percent of any gain may be excluded if the QSBS is acquired after February 17, 2009, and before January 1, 2011). The amount of gain exclusion permitted is the greater of (i) 10 times the taxpayer’s basis in the QSBS or (ii) $10 million. In general, QSBS is stock in a C corporation that conducts an active trade or business and has gross assets not exceeding $50 million at the time the stock is issued.
Under the Act, 100 percent of the gain from a non-corporate taxpayer’s sale of QSBS acquired after September 27, 2010, and before January 1, 2011, that is held for 5 years is excluded from taxable income and no regular or alternative minimum tax will be imposed on the gain.
Temporary Reduction in Recognition Period for S Corporation Built-in Gain Tax
When a C corporation converts to an S corporation the S corporation must generally pay a tax on gain that arose before the conversion to an S corporation, known as built-in gain, and that is recognized in the first ten years that the S corporation election is in effect. A C corporation is one that is taxed at both the corporate and shareholder level while an S corporation receives pass-through tax treatment and is taxed at the shareholder level only. An S corporation is formed by election and is only permitted if a number of specific requirements are met.
Under the Act, the recognition period for an S corporation to recognize built-in gain is reduced to seven years for taxable years beginning in 2009 or 2010 and to five years for taxable years beginning in 2011.
Eligible Small Business’s General Business Credit
A taxpayer’s general business credit is generally limited to the excess of the taxpayer’s net income tax over the greater of (i) the taxpayer’s tentative minimum tax or (ii) 25 percent of the excess of the taxpayer’s net regular tax liability over $25,000. General business tax credits that are greater than this limitation may be carried back one year and carried forward up to twenty years.
Under the Act, the general business tax credit of an eligible small business for 2010 may be carried back five years, instead of one year. These general small-business credits are not subject to the alternative minimum tax for 2010. For this purpose, an eligible small business is a non-publicly traded corporation or partnership that has average annual gross receipts for the three taxable years prior to the current taxable year of no more than $50 million.
Provisions Encouraging Small Business Investment and Growth
Expansion of Internal Revenue Code Section 179 Deduction Limits
Under Internal Revenue Code Section 179, a taxpayer may elect to deduct the cost of “qualifying property.” “Qualifying property” is depreciable tangible personal property that is purchased or used in the active conduct of a trade or business such as equipment purchased for business use, office furniture, or office equipment. For taxable years after 2007 and before 2011, the maximum amount a taxpayer may elect to deduct under section 179 is $250,000 of the cost of the qualifying property placed in service for the taxable year ($25,000 for all other taxable years). For taxable years beginning after 2007 and before 2011, this $250,000 maximum amount is reduced by the amount by which the cost of the qualifying property placed in service during the taxable year exceeds $800,000 ($200,000 for all other taxable years).
The Act increases the section 179 expensing limitation for 2010 and 2011 to $500,000 with a phase-out threshold of $2 million and allows taxpayers to expense up to $250,000 of the cost of qualifying leasehold improvement, restaurant, and retail property.
Bonus Depreciation
The Act extends for one additional year the temporary 50 percent depreciation bonus first enacted in the Economic Stimulus Act of 2008 and then renewed in the American Recovery Reinvestment Act of 2009.
Under this bonus depreciation provision, 50 percent of the basis of qualified property may be deducted in the year the property is placed in service and the remaining 50 percent is recovered under normal depreciation rules. Generally, qualified property includes (i) property with a MACRS recovery period of 20 years or less, (ii) water utility property, (iii) certain computer software, and (iv) qualified leasehold improvement property.
The result of the bonus depreciation extension is that it is generally available for qualified property the original use of which begins with the taxpayer and that is placed in service during 2008, 2009, 2010, or 2011 in case of certain property with longer production periods.
Provisions Promoting Entrepreneurship
A taxpayer may elect to deduct up to $5,000 of start-up expenditures in the taxable year in which the taxpayer’s business begins. The $5,000 amount is reduced by the amount which the total amount of start-up costs exceeds $50,000.
The Act increases the amount of start-up expenditures a taxpayer may elect to deduct from $5,000 to $10,000 and increases the deduction phase-out threshold so that this $10,000 amount is reduced by the amount which the total amount of start-up costs exceeds $60,000.
Other Provisions
The Act provides a deduction for health insurance costs in computing self-employment taxes in 2010.
The Act removes employer-provided cell phones and similar telecommunications equipment from “listed property” effective for taxable years beginning after December 31, 2009. By de-listing employer-provided cell phones, the Act removes the strict substantiation-of-use requirements and the limitation on depreciation deductions, and eases administrative burdens on employers, employees, and the Internal Revenue Service.
The Revenue-Raising Offset Provisions
The Act raises revenue through several information reporting and penalty provisions, some of which are listed below:
1. Recipients of real estate rental income that make payments of $600 or more to a service provider (such as a plumber or accountant) in the course of earning rental income must send an information return to the Internal Revenue Service and to the service provider.
2. The Internal Revenue Service may issue levies before a collection due process hearing occurs for federal contractors who owe federal taxes.
3. An increase on the penalties for failure to file correct information returns is imposed.
Michael G. Lapidus is the founder of the Law Office of Michael G. Lapidus. For tax controversy matters and business tax planning consulting needs, please contact Michael G. Lapidus at mlapidus@lapidustaxlaw.com.
Disclaimer Required by IRS Rules of Practice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. This publication is intended for general information purposes. It does not constitute legal advice. The reader should consult with knowledgeable legal counsel to determine how applicable laws apply to specific situations. Articles in this publication are based on the most current information available at the time they were written. Since it is possible that the law and other circumstances may have changed since this publication, please call us to discuss any actions you may be considering as a result of reading an article.
SBA Loans and the New Small Business Bill
Near the end of September 2010, President Barack Obama signed a Small Business Bill into effect. The new bill set aside $30 billion for small business lending. The law also includes $12 billion in tax breaks for small companies. This bill was signed into effect as a response to the 9.6 unemployment dissent in America. President Obama and the administration signed the bill to demonstrate an effort to decrease the unemployment levels in the United States. President Obama hopes that the loan will create as many as 500,000 new jobs within the next couple of years.
Small Business Jobs Act 2010 Changes
The Small Business Jobs Act includes the Recovery Act Loans Extension that provides $14 billion in lending support. Small Business Administration (SBA) Recovery loans will be extended under the law with a 90% guarantee and reduced fees. At the time that the bill was signed, 1,400 small businesses were waiting for funding. Since the signing of the Recovery Act, 70,000 Recovery loans have been supported. Over $680 million dollars have created $30 billion in lending support.
The bill supports higher loan limits, and the maximum loan sizes increased in the pre-established loan programs. The new bill also increases the 7(a) and 504 loan limits from $2 million to $5 million. Manufacturers may receive up to $5.5 million. The 7(a) loan program is one of the most flexible loan programs offered for start ups and existing small businesses. Most of these loans are gained through commercial lending institutions. The 7(a) loan program includes an Export Loan program and a Rural Lender Advantage program. Some businesses will be able to refinance and incorporate their commercial real estate mortgages into the 504 loan program. However, this only applies to owner occupied units.
Microloan limits increased from $35,000 to $50,000. These loans are designed to help entrepreneurs with large start-up companies and small businesses owners in underserved communities. The new bill also increases small business eligibility for SBA loans. They make this possible by increasing the “alternate size standard” to small businesses with less than $15 million in net worth. This also applies to those businesses with less than $5 million in average net income. The law also increases the amount of Small Business Administration (SBA) Express loans from $350,000 to $1 million. Working Capital and Commercial Real Estate Refinancing received temporary enhancements to assist small business owners.
Tax Cuts
The tax cuts include the following:
- More Deductions for Start Ups
- Deductions for Cell Phones provided by the Employer
- Self Employed Health Insurance Deductions
- Penalty limitations for small business tax reporting errors
- Accelerated or Bonus Depreciation
- Provisions for up to Five Years of Net Operating Losses
- Up to $500,000 for Small Business Expenses: The Highest Expense Ever
Fees Associated with the SBA Loans
Fees are assessed to offset the costs of the SBA loan to the taxpayer. Lenders are charged a guaranty fee and servicing fee for each approved loan loan. The fees are a percentage of the amount loaned to the borrower. The lender may charge the guaranty fee upfront. However, the borrower is not responsible for the lender’s annual fee.
ARC Loans
ARC Loans are small business loans that do not carry any associated fees. In the past, the fees for loans were between 1% and 3.5% of the total cost of the loan. ARC loans offer 100% guaranty from the SBA to the lender. No fees are required to be paid to SBA. Many of these loans are provided over a six month period. The repayment of the principal of the loan may be deferred for 12 months after the final disbursement of the loan. Repayment may last as long as five years. The best candidates for this type of loan are companies that have been profitable in the past, but are currently struggling. These companies may have begun to miss payments recently because of financial hardship. These funds may be used to make payroll, buy inventory or improve core operations.
7(a) Loans
Lenders will be charged an annual fee of 0.55 percent of the guaranteed portion of 7(a) loan. The fee will only be assessed to the balance of the loan and not the entire loan amount.
504 Loans
Borrowers will pay an annual fee of 0.749 percent on the outstanding balance of the 504 loan. This amount increased from 0.389 percent. Loan interest rates may not exceed 4.75% and may be as little as 2.25% when negotiated through a bank.
How Long is the SBA Loan Process?
Since the Small Business Administration is a guarantor and not a lender, the amount of time required to approve the loan will vary. The Small Business Administration attempts to reach its decision within seven to 21 business days from the receipt of the application. To accelerate the process, applicants should have several components of their application in place.
The length of time it takes for the SBA to respond to the application depends on the loan program your business elects to apply to. A business plan with financial statements is required for all loan programs. Earnings projections and collateral offerings must be established. In general, the SBA microloan is the least time consuming application and will be approved the fastest. The maximum loan amount was increased to $50,000. The funds cannot be used to buy property or pay debt.
Top Five SBA Loan Lenders
The banks have sorted SBA lending by region. Some of the most prominent banks involved in lending are the following:
Wells Fargo Bank
Wells Fargo managed a No. 1 ranking between October 1, 2009 and September 30, 2010 for the Small Business Administration 7(a) loan. The bank issued 91 SBA loans with a total value of $31.9 million. The bank was the second leader in terms of ARC loans. The bank issued 23 loans for a combined value $710,100.
JPMorgan Chase Bank
Chase Bank issued 33 ARC loans with a total value of $935,100. They ranked No. 1 in this category of loans issued.
Mortgage Capital Development Corporation
This particular bank issued the most 504 SBA loans. Businesses may use these loans for real estate purchases, property constructions and upgrades.
TMC Development
This bank issued 71 SBA loans for a combined value of $54.1 million. Nearly, 56 of these loans were 504 loans. The loans had a total combined value of $48.9 million.
Capital Access Group
Capital Access Group issued 51, 504 loans for combined value of $37 million.
Rates of Top Five SBA Loan Lenders
Wells Fargo
Typically, 3.5% of the SBA amount is due at the time of the loan. However, the fee may be financed. An origination fee may include bank fees. A fixed or variable interest rate will be negotiated by the bank for the Wells Fargo portion of the loan.
Chase Bank
A guaranty fee of 1% to 3.5% of the guaranteed amount must be paid by the lenders. The lender must also pay the annual fees of 0.25%. The lender may pass the guaranty fees onto the lender, but not the annual fees.
Mortgage Capital Development Corporation
This bank charges 0.389% of the balance of the loan for fees.
TMC Development
Most 504 loan programs will pay up to 90%. Therefore, most borrowers only have to make a 10% down payment. This bank offers a 4.39% interest rate to those seeking a loan. The fees are typically 1% or less.
Capital Access Group
Businesses may get up to 90% financing with a SBA loan. The interest rates are 4.40%. The fees are typically 1% or less.
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