Refinancing High Cost Debt

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Refinancing – What are your choices?

  • Traditional bank term loans and lines of credit: Some banks can refinance business debt as part of a larger loan. Traditionally, small businesses relied on their local banks for lines of credit, loans and refinances. However, in recent years, banks significantly increased their loan requirements, making it harder for businesses to refinance debt.  However, if you experience difficulty borrowing from a bank, SBA loans and loans from alternative lenders might be a good option.
  • SBA loans: The U.S Small Business Administration (SBA) offers special lending programs for small businesses that do not qualify for traditional financing. While the SBA does not provide the loans directly to the business owner, it provides loan guarantees to lenders. This guarantee gives lenders the ability to take on more risky businesses. You may have heard of the SBA 7(a), Community Advantage and Grow loans. These loans have a variety of loan purposes, including debt refinance.
  • Alternative lenders: There are a variety of non-bank alternative lenders that are working with small business owners these days. It can be tough to find a reputable one, so we recommend working with a Community Development Financial Institution, or CDFI.  These are mostly non-profit organizations that provide smaller dollar amount loans to businesses that do not fit conventional banking criteria.

Refinancing with an SBA Loan (7a and 504 programs)


SBA Loans – the Benefits

  • SBA Loans are some of the only loans available to some businesses because of the government guarantee.
  • SBA Loans have minimal equity requirements.
  • SBA Loans typically do not have balloon payments.
  • Both the 504 and the 7a offer long term amortizations for commercial real estate and “long life” equipment.
  • 504 loans have a “below market” 20 year fixed rate second mortgage.

Refinancing MCA Debt with SBA Loans

It is possible to refinance loans that small businesses have outstanding with the SBA 7(a) loan program. Basic requirements include that the purpose of the original loan(s) would have been SBA eligible.  The proposed loan needs to provide the borrower with a substantial benefit demonstrated by the payment amount being at least 10% less that the existing loan. A written justification for each loan must also be provided as to why the current loan is not on reasonable terms.

Examples of unreasonable terms may include:

  • a demand or balloon maturity feature in the existing note or the current maturity is not appropriate for original purpose
  • the existing debt being refinanced is on a revolving line or a credit card
  • interest rate exceeds SBA’s maximum
  • loan is over-collateralized
  • line of credit lender is unwilling to renew
  • debt was used for change of ownership  (seller financing must have performed for 24 months.)
  • Refinancing of same financial institution debt is possible but must document a 36 month payment history with no unjustified past dues (> 30 days).
  • Refinancing of an existing SBA loan is generally not allowed but may be considered if the borrower has new financing needs that the existing lender has declined or the existing lender has refused to modify the terms of the existing SBA loan to accommodate the new loan.
  • Punchline – By definition, because of their structure/cost, MCA debt is eligible for refinance

SBA 504 Program Requirements

Updated 2018: Guidelines for the SBA refinance program below. Here are the highlights from this permanent program:

  • Single purpose or special use properties such as hotels, assisted living, etc are eligible up to 90% LTV even though they would typically require more equity to be eligible for a 504. Other properties such as golf courses or bowling centers may also qualify for 90%.
  • 75% of the original debt had to be used to finance real estate and up to 25% of the debt to be refinanced could have been used for other business uses.
  • Debt to be refinanced must be in place at least two years from application date.
  • Business must have been in operation for two years prior to application date (and cannot have full or partial ownership change).
  • Max LTV is 90% if the refi includes real estate and equipment debt.  If refi includes cash out for “eligible operating expenses,” the max LTV is 75% with business operating expenses not to exceed 25%.
  • The loan to be refinanced must be current for the last 12 months.
  • You cannot refi an SBA 7a, 504, USDA or any other government loan*

* If may be possible to refi a 7a loan with another 7a if your current lender is unwilling or unable to do it for you.

Alternative Lenders (other than revenue lending)


Asset-Based Lending

An asset-based loan is typically given to businesses who have more orders than capital to fund.  This industry is not regulated, so typically asset-based loans are more expensive.  The allure of accelerating the cash conversion cycle can also ignite a vicious cycle of borrowing. Asset-based lenders are compensated based on the interest they charge customers, so they are incented to charge the highest rate you will agree to.  Unscrupulous lenders use prolonged application processes coupled with bait-and-switch tactics to string you along, wasting valuable time. Pay close attention to the fees, as they can be very creatively built into contracts.  But be cautious, asset-based loans are addicting and expensive for businesses. And definitely not for everyone.

Pawn Loans

Pawn Loans allow individual business owners to obtain short-term loans in exchange for hard valuable assets, like jewelry, gold, silver, etc. Unlike a bank, a pawn loan’s collateral is held by the lender and requires no credit checks, so your financial history won’t impact the terms. Instead, the value of the loan is determined by the value of the asset. A pawnshop will typically lend you a greater amount of money for your collateral, simply because if you fail to make payments, they will profit by selling your goods.  They can also purchase the item outright.

Pay close attention to hidden fees, minimum terms and interest rates with these types of loans. Since the terms of the loans are typically shorter, the effective annual percentage rate could be very high. Read every term and condition carefully as they will not discuss the negative aspects of their service. They will also notify you only once as required by law.  If you miss the due date, you risk losing the pledged item.

The biggest benefit of pawn loans is securing cash fast. If your financial situation is a short-term crunch but you are ensured of future cash flow – say from a tax return – this could be a good alternative for your business. Just make sure you don’t miss your payments.

Crowdfunding

Crowdfunding is quickly becoming a popular source for alternative funding, especially among independent artists, creators and business owners in recent years. Crowdfunder, GoFundMe and Kickstarter are the more popular lending platforms. Their fees vary but typical fees are 5 percent of the total amount raised.

A downside of crowdfunding is that it takes time to raise funds for your business.  Unlike a pawn loan, crowdfunding typically takes up to 6 months to raise capital. Another challenge posed by crowdfunding is that not every platform is created equal. It’s better to choose a website with user-friendly tools and a good track record of success.

There are multiple crowdfunding platforms for raising donations, rewards, equity and debt – but the most common platform is equity crowdfunding. Under this option, an investor gets equity in your company. Investors obtain a return on their investment in the form of dividend payments. Be prepared to share your business – and your control – under this option.

Refinancing High Cost Debt

Refinancing – What are your choices?

  • Traditional bank term loans and lines of credit: Some banks can refinance business debt as part of a larger loan. Traditionally, small businesses relied on their local banks for lines of credit, loans and refinances. However, in recent years, banks significantly increased their loan requirements, making it harder for businesses to refinance debt.  However, if you experience difficulty borrowing from a bank, SBA loans and loans from alternative lenders might be a good option.
  • SBA loans: The U.S Small Business Administration (SBA) offers special lending programs for small businesses that do not qualify for traditional financing. While the SBA does not provide the loans directly to the business owner, it provides loan guarantees to lenders. This guarantee gives lenders the ability to take on more risky businesses. You may have heard of the SBA 7(a), Community Advantage and Grow loans. These loans have a variety of loan purposes, including debt refinance.
  • Alternative lenders: There are a variety of non-bank alternative lenders that are working with small business owners these days. It can be tough to find a reputable one, so we recommend working with a Community Development Financial Institution, or CDFI.  These are mostly non-profit organizations that provide smaller dollar amount loans to businesses that do not fit conventional banking criteria.

Refinancing with an SBA Loan (7a and 504 programs)


SBA Loans – the Benefits

  • SBA Loans are some of the only loans available to some businesses because of the government guarantee.
  • SBA Loans have minimal equity requirements.
  • SBA Loans typically do not have balloon payments.
  • Both the 504 and the 7a offer long term amortizations for commercial real estate and “long life” equipment.
  • 504 loans have a “below market” 20 year fixed rate second mortgage.

Refinancing MCA Debt with SBA Loans

It is possible to refinance loans that small businesses have outstanding with the SBA 7(a) loan program. Basic requirements include that the purpose of the original loan(s) would have been SBA eligible.  The proposed loan needs to provide the borrower with a substantial benefit demonstrated by the payment amount being at least 10% less that the existing loan. A written justification for each loan must also be provided as to why the current loan is not on reasonable terms.

Examples of unreasonable terms may include:

  • a demand or balloon maturity feature in the existing note or the current maturity is not appropriate for original purpose
  • the existing debt being refinanced is on a revolving line or a credit card
  • interest rate exceeds SBA’s maximum
  • loan is over-collateralized
  • line of credit lender is unwilling to renew
  • debt was used for change of ownership  (seller financing must have performed for 24 months.)
  • Refinancing of same financial institution debt is possible but must document a 36 month payment history with no unjustified past dues (> 30 days).
  • Refinancing of an existing SBA loan is generally not allowed but may be considered if the borrower has new financing needs that the existing lender has declined or the existing lender has refused to modify the terms of the existing SBA loan to accommodate the new loan.
  • Punchline – By definition, because of their structure/cost, MCA debt is eligible for refinance

SBA 504 Program Requirements

Updated 2018: Guidelines for the SBA refinance program below. Here are the highlights from this permanent program:

  • Single purpose or special use properties such as hotels, assisted living, etc are eligible up to 90% LTV even though they would typically require more equity to be eligible for a 504. Other properties such as golf courses or bowling centers may also qualify for 90%.
  • 75% of the original debt had to be used to finance real estate and up to 25% of the debt to be refinanced could have been used for other business uses.
  • Debt to be refinanced must be in place at least two years from application date.
  • Business must have been in operation for two years prior to application date (and cannot have full or partial ownership change).
  • Max LTV is 90% if the refi includes real estate and equipment debt.  If refi includes cash out for “eligible operating expenses,” the max LTV is 75% with business operating expenses not to exceed 25%.
  • The loan to be refinanced must be current for the last 12 months.
  • You cannot refi an SBA 7a, 504, USDA or any other government loan*

* If may be possible to refi a 7a loan with another 7a if your current lender is unwilling or unable to do it for you.

Alternative Lenders (other than revenue lending)


Asset-Based Lending

An asset-based loan is typically given to businesses who have more orders than capital to fund.  This industry is not regulated, so typically asset-based loans are more expensive.  The allure of accelerating the cash conversion cycle can also ignite a vicious cycle of borrowing. Asset-based lenders are compensated based on the interest they charge customers, so they are incented to charge the highest rate you will agree to.  Unscrupulous lenders use prolonged application processes coupled with bait-and-switch tactics to string you along, wasting valuable time. Pay close attention to the fees, as they can be very creatively built into contracts.  But be cautious, asset-based loans are addicting and expensive for businesses. And definitely not for everyone.

Pawn Loans

Pawn Loans allow individual business owners to obtain short-term loans in exchange for hard valuable assets, like jewelry, gold, silver, etc. Unlike a bank, a pawn loan’s collateral is held by the lender and requires no credit checks, so your financial history won’t impact the terms. Instead, the value of the loan is determined by the value of the asset. A pawnshop will typically lend you a greater amount of money for your collateral, simply because if you fail to make payments, they will profit by selling your goods.  They can also purchase the item outright.

Pay close attention to hidden fees, minimum terms and interest rates with these types of loans. Since the terms of the loans are typically shorter, the effective annual percentage rate could be very high. Read every term and condition carefully as they will not discuss the negative aspects of their service. They will also notify you only once as required by law.  If you miss the due date, you risk losing the pledged item.

The biggest benefit of pawn loans is securing cash fast. If your financial situation is a short-term crunch but you are ensured of future cash flow – say from a tax return – this could be a good alternative for your business. Just make sure you don’t miss your payments.

Crowdfunding

Crowdfunding is quickly becoming a popular source for alternative funding, especially among independent artists, creators and business owners in recent years. Crowdfunder, GoFundMe and Kickstarter are the more popular lending platforms. Their fees vary but typical fees are 5 percent of the total amount raised.

A downside of crowdfunding is that it takes time to raise funds for your business.  Unlike a pawn loan, crowdfunding typically takes up to 6 months to raise capital. Another challenge posed by crowdfunding is that not every platform is created equal. It’s better to choose a website with user-friendly tools and a good track record of success.

There are multiple crowdfunding platforms for raising donations, rewards, equity and debt – but the most common platform is equity crowdfunding. Under this option, an investor gets equity in your company. Investors obtain a return on their investment in the form of dividend payments. Be prepared to share your business – and your control – under this option.

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