Low-Rate Lending Options for Small Businesses

Microloans and the Community Advantage Program are two ways you can potentially save on interest payments.

You got through the holidays and made it back to your business.  Congratulations!  Now it’s time to give your business a gift by lowering your interest rates. The coldest months are a good time to hunker down and analyze how to squeeze more profitability out of your income statement. Reducing interest expense is probably the least painful way to do so.

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    According to a study by the U.S. Small Business Administration Office of Advocacy, only 12% of businesses use a business loan for capital when they are starting out. Business and personal credit cards account for almost twice as much of entrepreneurs’ starting capital.  That’s a little surprising because most savvy business owners are aware that carrying balances on credit cards results in interest rates well over 16% these days, according to bankrate.com. Some “fintech” solutions may have effective interest rates that are even higher. The fintech industry includes names like OnDeck and Kabbage.

    Credit cards and fintech loans are easy and fast, and entrepreneurs love that combination. For many entrepreneurs, ease and speed are worth the extra expense, until they start adding up the cost. 

    Here are some options that might work for you.

    Microloans

    The SBA offers microloans to borrowers who, for whatever reason, cannot qualify for regular bank financing. When an entrepreneur gets started by running up credit card balances, it may adversely affect the personal credit score of the owner, a double hit because it locks out the entrepreneur from many typical routes of refinancing.  Enter the microloan.

    “Taking out too many credit cards will reduce personal credit scores and make it even more difficult for a traditional lender to offer a loan,” says Patty Ajdukiewicz, relationship manager for the Economic and Community Development Institute.

    The Economic and Community Development Institute (ECDI) provides SBA microloans to qualified individuals who can meet certain basic eligibility requirements and show repayment ability. Microloan rates range from 9% to 12%. That is more expensive than a traditional bank loan, but a fraction of the costs of credit cards and fintech.

    Ajdukiewicz notes entrepreneurs should anticipate having to pledge all available collateral when they refinance a credit card loan. While a credit card may leave fixed assets unencumbered, the lender is compensated for that lack of collateral with a high rate. An ECDI Microloan could cut the interest rate in half, but you should anticipate a lien against your business assets, and perhaps personal assets as well.

    Community advantage

    For slightly larger transactions, Growth Capital Corporation’s Community Advantage program is also available.

    “I’ve got one now that we’re approving today. They’re 13 years old and have revenues of $1.3 million.  They have over $100,000 in credit card debt. Thirteen years and they have never gotten good advice,” says Kate Kerr, program director.  She adds that most of the clients she works with have one or two credit cards, perhaps to take advantage of refund points or free travel. But some companies might end up with dozens of cards, and the debt load quickly becomes unmanageable. 

    A key difference between responsible term loans and credit card debt is the ease with which the transaction is completed. Credit cards are the easy path, but you pay for the convenience. Expect a much higher degree of due diligence from a lender like Kerr. The rate is much lower, but you must have your financial statements in order. 

    For example, businesses need to have their tax returns filed so that the loan can be underwritten, Kerr says. Your accountant may have the ability to get you an extension on your taxes, but if you’re in the process of applying for a loan, that is actually not at all helpful.  SBA-backed loans such as Community Advantage or microloan typically need financial statements current within 120 days of application.

    You can also refinance high-rate loans through most traditional banks. SBA’s loan guarantee programs are available to assist any participating lender, if there is not sufficient capital or time in business to justify a conventional loan. 

    If you must use fast credit, use the business name

    When the outstanding debt is in the name of the business, it is easier for a bank to refinance the higher rate debt. SBA only asks that the bank obtain the applicant’s certification that the debt incurred was exclusively for business purposes.  If the balance includes personal expenses as well, these amounts must be excluded.

    When the outstanding debt is in the name of the individual owner, it is much more difficult. Lenders must document the specific business purpose of the credit card debt and the applicant must certify that the loan proceeds are being used only to refinance business expenses. Documentation required will include a copy of the credit card statements and individual receipts of any expenses in excess of $250.

    If you must start your business on a credit card, at least try to get a card that is in the business name.  That will make a future refinance request much easier for the lender to process.

    Ray Graves works in lender relations in the SBA’s Cleveland office.

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    Next up: New Audit Rules for Partnerships, LLCs Taxed as Partnerships
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  • New Audit Rules for Partnerships, LLCs Taxed as Partnerships

    New rules have been introduced governing the auditing of auditing partnerships and LLCs that are taxed as partnerships. Here's what you need to know.

    The Bipartisan Budget Act of 2015 (the “BBA”), which implements new rules for auditing partnerships and LLCs taxed as partnerships (1) went into effect in January 2018. Under the new BBA procedures, if selected for an audit, any adjustment for a partnership tax year is determined at the partnership level. If the adjustment results in an underpayment of tax, the IRS will assess and collect the imputed underpayment, interest and penalties from the partnershipnot from the individual partners, and the payment will be determined using the highest individual or corporate rate of tax.

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    While any IRS adjustments will relate to the tax year reviewed, the imputed underpayment will be assessed in the adjustment year when the audit is completed. As a result, the remaining (or new) partners during the adjustment year may bear the underpayment liability, not the individuals who were partners during the reviewed tax year. The BBA allows partnerships to annually opt out of the BBA audit procedures. 

    This can be accomplished by making an annual opt-out election on a timely-filed partnership tax return. Because the partnership’s decision to elect out of the audit regime will be subject to IRS review, partners should consider including opt-out provisions within the tax matters provisions of their partnership or LLC operating agreements.

    In addition, every partnership subject to the BBA audit procedures will have a “partnership representative” for years beginning Jan. 1, 2018. A partnership representative has increased authority, as compared to the designation of the “tax matters partner” under the old regime. For instance, a partnership representative has the exclusive authority to represent a partnership during a tax audit and negotiate a settlement with the IRS.  

    The IRS has the right to designate the partnership representative if the partnership fails to do so in advance. Accordingly, it is advisable to update the tax matters provisions of the partners’ agreement to include the necessary designation.

    With the recent changes in tax laws effecting partnerships (including LLCs taxed as partnerships), business owners should consult with their tax advisors and legal counsel with respect to amending their partnership or LLC operating agreements.

    [1] Single-member LLCs and LLCs that have elected to be taxed as S-Corporations are not impacted by this change.

    This article is meant to be utilized as a general guideline for IRS rules for partnerships. Nothing in this blog is intended to create an attorney-client relationship or to provide legal advice on which you should rely without talking to your own retained attorney first.  If you have questions about your particular legal situation, you should contact a legal professional.

    Alex and the attorneys of The Gertsburg Law Firm now offer Cover My Six, a one-stop legal audit for your business, led by award-winning litigators and in-house counsel. CM6 minimizes your exposure to lawsuits, investigations, disgruntled employees and customers, and all the damage that comes with them. Visit www.covermysix.com to learn more about how to protect your business from lawsuits with this brand-new service.


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    Next up: Online Lending: 3 Perspectives from the Cleveland Fed
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  • Online Lending: 3 Perspectives from the Cleveland Fed

    In a recent report, The Federal Reserve Board and Federal Reserve Bank of Cleveland gauged the perception and understanding small business owners have of online lenders. Read on below for a summary of what the report found.

    The Federal Reserve Board and the Federal Reserve Bank of Cleveland recently published “Browsing to Borrow: “Mom & Pop” Small Business Perspectives on Online Lenders.” The study follows the release of a 2015 report, Alternative Lending through the Eyes of “Mom & Pop” Small-Business Owners: Findings from Online Focus Groups.

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    The report aims to gauge small business owners’ perceptions of online lenders, as well as their understanding and interpretation of the information that online lenders use to describe their credit products.

    There were three key takeaways from this study:

    Takeaway No. 1: Many participants were familiar with online lending. Most were familiar with at least one or two lenders on a list of the more prominent firms. Some had positive views of online lenders, the bulk of participants had negative thoughts about the industry. These negative impressions appear to be based, in part, on sales calls from lenders or brokers and frequent email and mail solicitations.

    Takeaway No. 2: Participants want to see websites with detailed product information: They want details about products and their costs, because the more info the better. When websites made you enter contact information before they provided information, users felt skeptical.

    Takeaway No. 3: Participants found sample online products confusing. Participants were given three sample online products, and they found the descriptions difficult to understand because of the lack of details. When features such as interest rate, payment amount, fees, etc., were displayed in an orderly manner, participants were pleased.

    Opportunity for online lenders?

    Nearly all participants agreed in their want for clear disclosure of product costs and terms, and the findings suggest that improved disclosures could benefit both lenders and borrowers. This presents an opportunity for online lenders to earn customers’ trust and grow their customer base. Borrowers could evaluate competing products based not only on the costs and features offered, but also the degree to which the lender is up front about important details.

    Click here to read the full report.

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    Next up: PODCAST: SBA's Raymond Graves and Compass Consulting Service's Tameka Taylor
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  • PODCAST: SBA's Raymond Graves and Compass Consulting Service's Tameka Taylor

    To help mark the Small Business Administration’s National Small Business Week, we recently invited the SBA’s Raymond Graves and our own COSE Expert Network member Tameka Taylor, president of Compass Consulting Services, in to discuss the state of small businesses today, the issues they’re facing, and the best way to overcome those challenges.

    To help mark the Small Business Administration’s National Small Business Week, we recently invited the SBA’s Raymond Graves and our own COSE Expert Network member Tameka Taylor, president of Compass Consulting Services, in to discuss the state of small businesses today, the issues they’re facing, and the best way to overcome those challenges.

    Topics covered during the podcast include:
    •    employee retention;
    •    workplace communication;
    •    the economic climate for small business; and
    •    social media best practices.

    Listen to the podcast here.

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    Next up: PODCAST: What Every Small Business Owner Should Know Before Visiting Their Lender
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  • PODCAST: What Every Small Business Owner Should Know Before Visiting Their Lender

    COSE recently sat down with the Small Business Administration’s Ray Graves and Compass Consulting’s Tameka Taylor to talk financing. More specifically, we wanted to know what sort of things entrepreneurs should keep in mind when it’s time to approach their lender for financing. Want to hear their insight? Download the podcast.

    COSE recently sat down with the Small Business Administration’s Ray Graves and Compass Consulting’s Tameka Taylor to talk financing. More specifically, we wanted to know what sort of things entrepreneurs should keep in mind when it’s time to approach their lender for financing. Want to hear their insight? Download the podcast.

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    Next up: SBU Analysis: Drilling Into the Numbers
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  • SBU Analysis: Drilling Into the Numbers

    In my last blog on this subject (which I suggest you read before reading this blog), I described how the typical income statement masks the real causes of performance (both good and bad) for all but the simplest of companies.

    In my last blog on this subject (which I suggest you read before reading this blog), I described how the typical income statement masks the real causes of performance (both good and bad) for all but the simplest of companies.

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    So, let's take a look at another company which has more than one group of customers and products/services. The example here is for a hypothetical swimming pool/spa firm (disclosure: I served on the board of such a company for several years, but the example does not portray the performance of that firm). 

    The traditional income statement for this firm looks like this:

     

    $

    %

    Sales

    2,000,000

    100.0

    Cost of sales

    1,400,000

    70.0

    Gross margin

    600,000

    30.0

    As portrayed in the first blog, the cost of sales includes direct labor, materials and managerial expenses. The first takeaway is that this firm, in the year shown, has $600,000 to cover all other expenses (i.e., rent, insurance, utilities, etc.) and pre-tax profit. 

    Unfortunately, this traditional income statement does not give a true picture of where the company is making money—or losing it—because it lacks the detailed examination of the profitability of customer groups and product/service groups.

    This firm has three Strategic Business Units (SBU): Pool Design, Chemicals, and Repairs/Maintenance. The analysis of those three SBUs shows the following:

     

    Design ($)

    Design (%)

    Chemicals ($)

    Chemicals (%)

    Repair/Maintenance ($)

    Repair/Maintenance (%)

    Sales

    200,000

    100.0

    1,000,000

    100.0

    800,000

    100.0

    Cost of sales

    140,000

    70.0

    680,000

    68.0

    580,000

    72.5

    Gross margin

    60,000

    30.0

    320,000

    32.0

    220,000

    27.5

    Obviously, these three SBUs are not equal in size or performance. And that is typical when you employ an SBU analysis of performance. Without knowing anything about any given company's SBUs, I already know two things:

          1. Not all SBUs are created equal in size and/or performance.

          2. Not all SBUs have the same potential for growth and profitability.

    So let's dig down some more. Each of these SBUs have distinct customer groups into which the firm sells. Let's take them one at a time.

    Pool Design

    Pool Design is a relatively specialized service few pool service companies offer, and this SBU represents a distinctive competence of this firm. From a cost standpoint, most expenses are for highly skilled engineering talent and CAD hardware and software. This portion of the business is highly cyclical—in a slow year, the full talents of an engineering staff are underutilized; in growth years, the full time engineering staff is hard pressed to handle the volume. Contract labor is adjusted up or down to keep the SBU in balance. Design frequently presents add-on opportunities to capture new Chemical and Repair/Maintenance customers. This SBU has two separate sets of customers: Municipal/Institutional customers and Hotel/Fitness Center customers.

    Let's see what this SBU looks like when breaking it into two SBUs:

     

    Municipal/Institutional ($)

    Municipal/Institutional (%)

    Hotel/Fitness Center ($)

    Hotel/Fitness Center (%)

    Sales

    120,000

    100.0

    80,000

    100.0

    Cost of sales

    84,000

    70.0

    56,000

    70.0

    Gross margin

    36,000

    30.0

    24,000

    30.0

    This is one of those rare times where both SBUs have the same Gross Margin percentage. If viewed from a new customer acquisition process, these two SBUs are "keepers" as long as labor costs are kept under control.

    Chemicals  

    Pools and spas require regular testing and chemical products to maintain water quality. Chemicals are delivered via tank trucks (larger quantities) and in smaller containers that might be delivered with small vans or pickup trucks. In either case, but especially in the case of the tank trucks, drivers must have commercial licenses and all personnel need to have HAZMAT certification. This area of business serves three separate customer groups: Home, Municipal/Institutional, and Hotel/Fitness Centers.

    Let's see what these SBUs look like:

     

    Home ($)

    Home (%)

    Muni/Institutions ($)

    Muni/Institutions (%)

    Hotel/Fitness ($)

    Hotel/Fitness (%)

    Sales

    500,000

    100.0

    300,000

    100.0

    200,000

    100.0

    Cost of sales

    300,000

    60.0

    240,000

    80.0

    140,000

    70.0

    Gross margin

    200,000

    40.0

    60,000

    20.0

    60,000

    30.0

    The Home customer SBU carries the highest margin as well as the highest sales. Deliveries can usually be made one or two times per month in season and often with less expensive driver labor. Municipalities and Institutions tend to be larger volume accounts that are serviced more often than the Home customers and usually by the higher cost tank trucks. Because of the gallonage requirements of these customers, other pool supply firms often bid at low margins to capture the volume business. It should be noted also that municipalities and sometimes institutions tend to pay slowly. The Hotel/Fitness segment presents many of the constraints in pricing and delivery found in the Municipal/Institutional market, but the margins could be higher because of other relationships (i.e., the firm's Design SBU might give a leg up on the competition). 

    So, this level of analysis for the Chemical market present very different sales volumes and margins. If the owner has a choice, which of the three SBUs would he want to grow, given the above information?  If this level of analysis were not available to him, he would have to make strategic decisions with insufficient information about profitability and volume.

    Repair/Maintenance

    This segment of the business is a logical extension of services to Chemical customers as well as those who don't buy pool/spa chemicals from this firm. The major requirements in this SBU are for trained and experienced service technicians who have good trouble-shooting and problem-solving skills. Obviously, these technicians require a service vehicle and appropriate tools. They tend to be relatively highly paid, and the firm's ability to control labor costs and hold to established hourly billing rates is essential to success. The Repair/Maintenance segment services the same three customer groups as the Chemical segment.

    Let's see what this segment looks like broken into three SBUs:

     

    Home ($)

    Home (%)

    Muni/Institutional ($)

    Muni/Institutional (%)

    Hotel/Fitness ($)

    Hotel/Fitness (%)

    Sales

    400,000

    100.0

    300,000

    100.0

    100,000

    100.0

    Cost of sales

    280,000

    70.0

    240,000

    80.0

    60,000

    60.0

    Gross margin

    120,000

    30.0

    60,000

    20.0

    40,000

    40.0

    As with the Chemical segment, the sales volumes and gross margins of these three SBUs are very different from each other. Again, absent this level of analysis, a decision maker would have a hard time determining which SBUs to grow and/or which SBUs to "fix" (such as the Municipal/Institutional SBU, which carries a very low gross margin).

    Takeaways

    Given the above, here are four things you can take away from what you just read:

    1. Drilling down inside the business creates a very different picture of a complex (i.e., multi-SBU) enterprise than the traditional income statement provides.

    2. Most businesses that are not organized to capture financial performance information by groupings of customers and products/services need to convert their financial information systems to capture the proper data. In my experience, this could easily be a major goal for the management team for at least two quarters if not more. It requires re-thinking about how the firm does business.

    3. What is shown above could easily be drilled down even further. For example, are there major customers inside a given SBU that are unusually profitable or unusually unprofitable? 

    4. Pareto, the Italian economist, came up with Pareto Analysis at least 500 years ago and states that 20% of a typical company's customers make up 80% of the firm's volume. That same 20% may or may not generate 80% of the firm's profitability. Doing a Pareto Analysis SBU-by-SBU frequently provides additional insights and might well be a strategic exercise worth doing.

    Jeffrey C. Susbauer, Ph.D. is Associate Professor Emeritus at the Monte Ahuja College of Business, Cleveland State University where he has taught strategic management and entrepreneurship courses since 1970.  A long-time consultant to scores of businesses, a member of the boards of advisors to over 60 companies, he co-founded and serves as the principal instructor for the COSE Strategic Planning/CEO Development Course for the past 36 years. The course is concerned with providing entrepreneurs with education to guide their vision, strategic thinking and execution in their businesses.

    Learn more about the Strategic Planning/CEO Development course or contact Jeff via email.

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