Question: Financing options for a small businesses

We are a small business with about a million dollars in annual revenue. We have an SBA loan for about $450K (originally a business acquisition loan for $880K in 2006).

We are looking for about $150K additional funding for working capital / business expansion. Owner's credit score is about 658 (no bankruptcies).

Please advise on the options for a term loan (7 years or longer) and a way to evaluate options.

4 Expert Insights

In order to provide you with your specific options, I would need much more information about the business, its profitability, cash flow and balance sheet. Generally speaking, you may want to see if the business and its owner qualifies for an SBA loan, or approach an asset based lender to discuss a line of credit that will support your working capital needs.

Agree with the comments by Yoav above.  Options for funding depend on the business entity (corporation, sub-chapter S, LLC), its current cash flow, interest cover ratio, current profitability and forecasted profitability.   Accounts receivable factoring could be used  as short term solution.  Owner may want to look at new SBA loan that combines the original loan outstanding balance of $450 and the additional $150 into a new loan.  Things to consider would be terms and conditions of the existing loan (i.e. penalties, interest rates, fees, etc.) and new loan terms.

Is the $150k you seek for working capital or for business expansion? There is a big difference! At Harvard Business School, there is a case, called Butler Lumber which is exactly on this point. A working capital loan is used to finance accounts receivable or inventory, typically for less than a year. One would expect to pay a commercial bank Prime plus 1% or 2%, or 7% to 9% APR currently.

A business expansion loan to invest in R&D, new product development, or small related acquisitions. The key difference is that this is not a one year loan, it's longer term, and could be viewed as permanent capital for your business. A commercial bank would be reluctant to make this sort of loan. Better sources would include angel investors, venture capitalists, private equity firms, or investment banks targeting small businesses. The price, or interest rate, on this type of loan should be expected to be more akin to an equity capital investment return rate, for example 15% to 25%.

In Butler Lumber, the lesson was, that when you do the monthly or quarterly cash flow analysis, you find that the requested working capital loan is in fact a business expansion loan.

In your question, you mention 7 year funds, implying that it's a business expansion loan. Because the 7 year loan may cost you 15% to 25% per year in interest, or giving up some equity in your company, I suggest that you follow two courses of action:

1. Do the cash flow analysis, and see if you can get a conventional, one year or less, working capital loan from a bank, at the lower cost estimate of 7% to 9%.

2. If you have any assets inside or outside your business which are unencumbered, and can be readily collateralized, such as land or real estate, then seek a conventional mortgage loan on that asset, hopefully at interest rates below 5%.

Pursuing either of the above suggestions could get you a portion or all of the $150k you seek and much lower cost than a business expansion loan, or permanent capital.

Currently, you are 45%, debt to revenue.  What are you planning to use the next $150K for?  If it's not revenue generating, I would think twice about taking on more infrastructure debt.  With a 658 credit score, you are not going to get the best financing available either.  Expansion is a great way to realize greater business opportunities but only if your existing operation is solid (good cash flow and growing top line).  If not, financing expansion to buy your way out of a debt situation is something you should seriously rethink.