Understanding the Accredited Investor Rule 501 of Regulation D

Understanding the Accredited Investor Rule 501 of Regulation D

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An accredited investor in the United States is an individual or entity that meets specific criteria set by securities regulators under the Securities and Exchange (SEC) Rule 501 of Regulation D, allowing them to participate in unregistered securities unavailable to the general public.

These criteria ensure accredited investors have sufficient financial sophistication and resources to understand and bear the risks of such private placements and similar transactions.

When seeking money for your business, it is necessary only to approach accredited investors because regulations restrict the types of investors allowed to participate in such private placements.

By limiting investments to accredited investors, regulators aim to protect less sophisticated investors from the higher risks associated with certain types of investments, such as private placements or hedge funds.

To qualify as an accredited investor, an individual must typically meet one or more of the following criteria:

  • Income Test: The individual must have earned income exceeding a certain threshold (e.g., $200,000 per year for the past two years or $300,000 with a spouse) and expect the same income level in the current year.
  • Net Worth Test: The individual must have a net worth exceeding a certain threshold, individually or jointly with their spouse (e.g., $1 million excluding the value of their primary residence).
  • Professional Credentials: 
    • Certain individuals with specific professional credentials or designations may qualify as accredited investors. This may include licensed securities professionals holding the general securities representative license (Series 7), the investment advisor representative license (Series 65), or the private securities offerings representative license (Series 82).
    • A person may also be considered an accredited investor if they are a general partner, executive officer, or director for the company issuing unregistered securities.
    • Knowledgeable employees of a private fund also qualify as accredited investors.

In addition to individuals, certain entities such as trusts, corporations, and certain types of partnerships may also qualify as accredited investors if their assets or net worth exceed $5 million.

The minimum financial requirements to be a qualified individual accredited investor are subject to change based on regulations and may vary by jurisdiction. It’s essential to consult legal and financial professionals or refer to the specific regulations in your jurisdiction for accurate and up-to-date information.

As a potential investor in a private placement, a structured product, or a private equity or hedge fund participant, it’s your responsibility to affirm truthfully your status as an accredited investor.  It is not sufficient to simply state you are an accredited investor. You should be prepared to prove it by providing the parties with the transaction documentation to support your claim.  Such documentation would include your federal tax returns for the previous two years, proof of your current income, a financial net worth statement, an accredited investor verification letter from your financial and/or tax advisors or attorney, and any other requested information.  

Similarly, those seeking investment from investors should diligently confirm that the parties they are dealing with are verified accredited investors.

 

Employee Retention Tax Credit Guide January 2023 Update

Employee Retention Tax Credit Guide January 2023 Update

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Employee Retention Credit

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The Employee Retention Tax Credit (ERTC aka the ERC) applicable to the Covid-19 pandemic has been evolving from its initial congressional act in March of 2020, was enhanced by the Consolidated Appropriations Act passed in January 2021, updated by the American Rescue Plan in March of 2021, and most recently updated by the Infrastructure Investment and Jobs Act.

If your head is spinning as you try to unravel the ERC rules, you are not alone.  I’ve read several dozen articles, attended multiple continuing education classes and even dug into the legal text and have concluded applying for the ERC is not for the faint of heart.  

To assume a small business owner is equipped to figure out what to do (or not do… more on that later) to maximize their pandemic financial support in the form of the ERC offered by the US federal government is a stretch, at best.  

There is a silver lining though.  If your business qualifies, you may retroactively apply for the employer payroll tax credits.  Albeit, there are deadlines approaching because the first quarter of 2020 Federal Form 941 amendment (which is how an employer files for the ERC) must be submitted by April 30, 2024.

This post covers those businesses affected by the Covid19 Disaster and defined by the IRS as a Small Employer, which employs up to 100 Full Time Equivalents (FTEs) in 2019 when applying for the 2020 ERC and up to 500 FTEs in 2019 when applying for the 2021 ERC.    

In summary, this Employee Retention Tax Credit Guide covers the following questions:

The purpose of this guide is to help business owners understand if pursuing the ERC is possible for their business and if so, when and how they should initiate the process.

 

What is the Employee Retention Credit

Although the ERC is a payroll tax credit available to both Covid-19 and NON Covid-19 disasters, for the purpose of this post, we will be addressing only the Covid-19 disaster scenario.  

Generally speaking, if you have a business where you employ people and pay them with a paycheck, withhold payroll taxes and file quarterly 941 federal tax forms, you may be able to file for the ERTC for all quarters in 2020 and the first three quarters of 2021.  

The ERC is a tax credit that is taken against payroll taxes if your business was subject to one or more government-mandated suspension of operations and/or your business gross income suffered in 2020 and/or 2021 when compared to pre-pandemic quarters in 2019.  

The ERC amount per employee maxes out between $5,000 in 2020 and up to $28,000 in 2021. 

Initially, the first law prevented a business owner from applying for the ERC if they’d applied for PPP loan forgiveness.  For this reason, many employers ignored the ERC.  This restriction has been lifted, albeit it takes a certain amount of  financial gymnastics to properly calculate the ERC, especially if you want to maximize the ERC as well as the PPP loan forgiveness.  More on that in a bit.

 

Employee Retention Credit 2020 and 2021 Eligibility

Whether your business is eligible for the ERC depends on whether it was in business in 2019, how much its Gross Receipts declined when compared to previous quarters or if it was subject to a government mandated partial or full suspension.  With the passing of new laws and release of additional FAQs, the ERC rules continue to change quarter-by-quarter and year-by-year, so a chart is the best way to summarize ERC eligibility.

ERC Eligibility Summary
For those employers that did not qualify under the Gross Receipts Decrease scenario, they may qualify for the ERC if they were subject to and affected by a government mandated partial or full suspension of operations.  

According the the Cares Act Code Section 2301 (c)(2), “a suspension by governmental authority means any employer for which the operation of the trade or business is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings for commercial, social or other purposes due to Covid-19.”

Worth noting is certain clarification found in the  IRS FAQs #28 regarding governmental orders.  This FAQ clarifies that unless the employer’s operation of its trade or business is affected by the governmental order, the suspension does not rise to the level of a governmental order for purposes of the ERC.

The National Law Review has a comprehensive resource of the states’ Covid-19 public information and announcements. 

Another resource for all 50 states covering shut down orders, mask mandates and travel restrictions may be found on Justia.com.

If your business intends to qualify for the ERC under the non-revenue provisions, it’s vitally important that you obtain the substantiation for the operational suspensions (shut downs and/or supply chain disruptions) for your records.  Keeping the documentation in a safe place so you are able to provide evidence in the future is highly recommended.  Simply assuming a shutdown in your state or a global supply chain restriction qualifies your business for the ERC is not enough.

And one more thing to consider is whether your business (or entity) has common ownership or is an affiliated service group with another business.  If so, there are additional steps to consider.

 

Employee Retention Credit 2020 and 2021 Calculation

The first step to calculate the ERC for quarters in 2020 and 2021 is to understand the maximum ERC, the ERC Tax Credit Rates, Compensation Base and the Types of Employer Payroll Taxes which the employee retention tax credits will offset.  

The PPP Loan forgiveness will come into play as well because the current law permits a business to apply for loan forgiveness and the ERC as long as it doesn’t use the same wage payments (compensation and certain healthcare insurance premiums).  

Note:  The Infrastructure Investment and Jobs Act retroactively removed the 4th quarter of 2021 from eligibility for most employers.

The following summarizes these variables for the 2020 and 2021 quarters:

ERC Maximum Amounts by Year

Qualified Wages for Employee Retention Credit

It’s important to understand that to compute the ERC qualified wages (which includes other forms of employee compensation) you will have to do so for each employee and for each quarter.  Unfortunately, there are no shortcuts.

All employees on the payroll may be included in the compensation calculation for ERC purposes, regardless of their full-time or part-time status, with one exception.   And that exception is a non-spouse relative of a corporation’s greater than 50% shareholders (or for any other entity other than a corporation, greater than 50% of the capital and profits interests in the entity).  Any non-spouse relative of a greater than 50% owner does not qualify for the ERC!  

According to IRS FAQ #59  non-spouse relative is defined as: 

  • a child, descendant of a child; or
  • brother, sister, stepbrother or stepsister; or
  • father, mother or ancestor of either; or
  • stepfather, stepmother; or
  • niece or nephew, aunt or uncle; or 
  • son-in-law, daughter-in-law, father-in-law, mother-in-law, and brother-in-law or sister-in-law.  

More than 50% owners and their spouses may not be included in the ERC compensation calculations, unless they have no family.  Yes, you read that correctly.  The compensation paid to a person who has more than 50% ownership in the business and their spouse is not eligible for the ERC unless they have zero living relatives.  In my opinion, it would have been easier for the IRS to say — if you own more than 50% of the business, you and your spouse can’t include your compensation for the ERC!

Also worth noting, is that the payroll costs include the gross payroll before deductions actually paid during the quarter.  The eligible payroll costs are not accrual basis (recorded when earned), instead the eligible payroll costs are cash basis (as when paid on payday).  This actually makes things much simpler and is consistent with the way in which payroll tax reports are prepared.  

ERC qualified wages are defined by the CARES Act Code Section 2301 (c)(3) and IRS Notice 2021-20 Q&A #30.  

For small employers, the wages paid to all employees whether working or not working, is considered eligible for the ERC.

Qualified wages do not include qualified sick leave wages and qualified family leave wages under section 7001 and 7003 of the Families First Coronavirus Response Act.  

The ERC compensation computation for all of the quarters in 2021 may include pay raises and bonuses, if reasonable up to a maximum compensation amount of $10,000 per quarter per employee.  This was not the case in 2020 where the number of full-time equivalents (FTEs) dictated how pay raises and bonuses would be handled.  If the business had less than 100 FTEs in 2019, all wages including bonuses were ERC eligible in 2020.  If there were more than 100 FTEs in 2019, pay raises and bonuses were not eligible for the ERC in 2020.

Similar to the PPP Loan Forgiveness program, certain health insurance costs may be included in the ERC wage / compensation base when applying the tax credit percentage.  The health insurance costs eligible for the ERC wage base include:

  • The amounts paid by the employer for employer-funded health plan (Code Section 5000 (b)(1) as long as it’s excluded from the employee’s compensation (under Code Section 106 (a)) even if the employee was not paid wages for services; and
  • The amounts paid by the employer for a group health care plan under Code Section 125 FSA.

And one other pre-tax employee wage/salary reduction that qualifies for the ERC wage base is the contributions from the employee to their qualified retirement plan (such as a 401K).  

 

How to Apply for Employee Retention Credit

As of January 2023, to claim the ERC, you must file an amended Federal Form 941 for the applicable quarter.  Keep in mind:

 

  • The Federal Form 941 is a quarterly report and is due on the last day of the month following the end of the quarter.
  • You have three years from the due date of the Federal Form 941 to file the amendment.

Employee Retention Credit vs PPP Loan

The ERC is less favorable than the forgiven PPP Loan and the current law allows an employer to apply for the ERC as well as to use the PPP Loan proceeds to keep their business going.  However, the employer can’t double dip by using the same payroll dollars and health insurance expenses from the PPP Loan forgiveness program for the ERC.  

So, it’s a matter of optimizing the two programs for as many dollars as possible to remain available for the ERC during the quarters in which the business is eligible while allowing enough payroll costs to be used during the PPP loan covered period to achieve 100% forgiveness.  Easier said than done!

Unfortunately, many employers filed for PPP Loan forgiveness for the first round without regard to the payroll costs being used up that later would have benefited them for the ERC program.

Why would an employer have done this?  Because, the rules kept changing and their crystal ball was broken! 

 

Is the ERC Taxable?

Not exactly.  The ERC amount received is not included in taxable income for the employer.  However, the ERC received in a given year will require the business entity (the employer) to reduce the amount of wages expense by the ERC dollars received in the year for which the ERC was applied.

For example, if the ERC for calendar year 2020 was $40,000., then the compensation (wages and health insurance costs) deduction for tax purposes is reduced by the ERC amount of $40,000.  Essentially, it results in taxable income (or a reduction in the reported tax loss) for the employer equal to the ERC amount received in the year in which it was applied for.

Conclusion

The ERC is a valuable benefit for small business owners who’ve been adversely affected by the pandemic.  Navigating the ERC eligibility, how much the benefit may be and how to apply has been and will continue to be a big challenge for business owners and their advisors alike.  

Many CPA firms simply don’t have the personnel to handle these applications due to their complexity — especially during tax season.  Unfortunately, many ‘pop up ERC filing businesses’ have come out of the woodwork.  Recently, the IRS Press Release (IR-2022-183 10/19/2022) stated: “Employers are warned to beware of third parties promoting improper Employee Retention Credit claims.”

I caution business owners to be careful who they work with, especially when it involves their tax filings. It’s best to use a CPA or law firm that specializes in this type of work.  They will thoroughly evaluate your situation, document the files, prepare your amended federal form 941and defend you if audited.

This post has been drafted based on the information published by the IRS and available to taxpayers and tax practitioners as of January 27, 2023.  If additional guidance is offered by the IRS, the post will be updated.  I promise.

EIDL Round 2 — SBA Expands Covid-19 Loans Again

EIDL Round 2 — SBA Expands Covid-19 Loans Again

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EIDL Round 2

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NOTE — THIS POST HAS BEEN UPDATED BASED ON SBA UPDATES PUBLISHED ON FEBRURARY 1, 2021 AND MARCH 24, 2021, MAY 28, 2021, JULY 1, 2021 and SEPTEMBER 8, 2021.

The Consolidated Appropriations Act of 2021 replenished the pool of EIDL money by $20Billion and the application deadline for the Small Business Administration’s (SBA) Economic Injury Disaster Loan (EIDL) program has been extended to December 31, 2021.  This extension, unofficially referred to as the EIDL Round 2, is welcome news for many business owners suffering as the result of the ongoing pandemic. 

The extension is part of the second Covid-19 Relief Bill signed into law on December 27th, 2020.  While this part of the relief bill extends most of the provisions in the first EIDL program, little attention has been paid to it by the press.  For this reason, we feel it is worthy to highlight its key provisions and the rules for the new targeted EIDL Advance, which is a grant.

EIDL Loan Program Key Provisions

  • Eligible Borrowers include small business owners and agricultural businesses with 300 or less employees, non-profits in the US states, Washington D.C. and territories who have suffered a temporary loss of revenue due to the pandemic.  
  • Use of Proceeds include working capital, operating expenses such as payroll, healthcare insurance premiums, rent, utilities, existing fixed debt payments, including federal business debt payments as well as the prepayments of commercial debt.
  • 30 Payment Term at 3.75% Fixed Rate for businesses and 2.75% Fixed Rate for nonprofits, with no pre-payment penalty.
  • Up to $2,000,000 may be borrowed, effective September 8, 2021.  If a borrower was previously subject to the former lower loan limits of $150,000 and $500,000, they may apply for an increase based on the new 24 month computation for qualification.  To apply, login to your SBA EIDL portal and look for the button that says Request an Increase.  If the button is not found on your portal main page, you will need to send the SBA an email to

    Co***********************@sb*.gov











     with the “EIDL Increase Request for (insert your)10-digit application number” in the subject line.  Include in the body of your email the following information:  

    • Loan Application Number
    • Loan Number (not the same as your loan application number!)
    • Full Business Name
    • Business Address
    • Business Owner(s) names
    • Phone Number
  • No Collateral Requirement if EIDL is less than $25,000; If more than $25,000 the SBA files a General Security Agreement (UCC-1) form to collateralize the business’ assets.  If EIDL is $200,000 or more, business owner collateral is required.
  • Deferred payments will be granted for loans made in 2020 as well as 2021 for 24 months from the date of the note.  During this deferred payment period interest on the note will accrue.  
  • For those businesses that received Emergency EIDL Advance (or Grants), the grant may be excluded from gross income on its tax return and is no longer required to be repaid if the business also received a PPP Loan which is fully forgiven.  Prior to the Consolidated Appropriations Act of 2021, if a PPP Loan was forgiven and the business also received an EIDL grant, the EIDL grant would be converted to a loan under the PPPL terms. 

New Targeted EIDL Advance Grants

When the original EIDL program launched in mid-2020, it included for applicants an Advance Grant amount of up to $10,000.  To qualify for the first grant, a business would apply for the EIDL via the SBA’s website and within a matter of a few days would receive a deposit in its business bank account equal to $1,000 multiplied by the number of full-time employees (up to $10,000).  By mid July, 2020, the SBA stopped making these grants because it ran out of money earmarked for the grant program.

The Consolidated Appropriations Act 2021 provides for an additional $20 Billion in grants to be distributed through the new targeted EIDL Advance program.  

This time, an applicant must qualify for the EIDL advance as follows:

  • There must be an economic loss of more than 30% measured by comparing any eight-week period between March 2, 2020 and December 31, 2020 to the comparable eight-week period during 2019; and  
  • The business must be located in a low-income community; and
  • The business may not employ more than 300 employees; and
  • The business must apply to the SBA by December 31, 2021. * AS OF MAY 28, 2021, THE SBA ANNOUNCED THE EIDL GRANT PROGRAM IS OUT OF MONEY.  IN THE FINAL WEEK OF JUNE 2021, THE SBA OPENED THE EIDL GRANT PROGRAM AGAIN.  SEE BELOW FOR UPDATED INSTRUCTIONS TO APPLY:

If an eligible business (see above) previously applied for the EIDL, they no longer need to wait for an email to be considered for the Targeted Advance grant.  Instead, the applicant should call the SBA’s Disaster Customer Service Center at 800 659-2955 or email

Ta*************@SB*.gov











 to request an invitation.

If an eligible business did not apply for the EIDL program and would like to apply for the Targeted (or Supplemental) Advance grant, the should apply on the SBA Disaster Loan Assistance Application portal here.

Similar to the first round, it is not necessary for the business to accept the EIDL if it’s ultimately offered by the SBA.  The business may keep the EIDL grant money received.

The Targeted EIDL Advance is being made available to two groups of applicants.  The first group are those businesses and non-profits that received less than $10,000 the first time and the second group are those businesses and non-profits that did not receive any EIDL Advance due to the funds being exhausted.

If the business currently meets the eligibility criteria above, the SBA will send an email invitation directly to the applicants who did not receive the full $10,000 EIDL Advance or received no advance due to lack of funding in the summer of 2020.  Upon receipt of the email from the SBA, the applicant may apply for the Targeted EIDL Advance.

It appears the SBA has lifted the former requirement that the applicant will be eligible to apply for the new, Targeted EIDL Advance only if they had applied for the EIDL program on or before December 27, 2020.

How to Apply for the EIDL Loan Program (not the EIDL Advance Grant)

As of July 1, 2021, the SBA has opened up EIDL Program applications again which means first-time applicants may apply on the SBA’s website here.

Below are a few tips based on our clients’ experiences when applying for the EIDL program:

In our practice, we’ve been involved with a number of clients who applied for the EIDL round one.  A few of them did so in haste and spent the better part of the last six or so months trying to resolve their sloppy application.  The SBA will reject an EIDL application if anything on the application doesn’t line up properly.

When you apply for the EIDL program, be certain the name of the business and its business address matches exactly what’s on your federal tax return and your business bank account.  And verify the EIN used in the application matches the EIN on your business tax return.

Applicants often make the mistake of guestimating their 2019 gross revenue and cost of goods sold.  Do not make this mistake.  Look very carefully at your 2019 federal tax returns and find the figures in the Gross Revenue and Cost of Goods Sold boxes.  Again, if you don’t get this right, your application will likely be rejected by the SBA.  

The Gross Revenue and Cost of Goods Sold figures will drive the amount of EIDL because it determines the amount of working capital you need to operate your business. The EIDL loan is based on your business’ required working capital so it’s very important to get it right.

You should also be prepared to deliver the IRS Form 4506-T for your business.  This form allows the IRS to pull your federal tax forms for your business for them to review.  Technically, it’s the tax transcripts they will review.  They will be looking at whether you’ve filed your and paid your federal taxes.  

And if you get past these couple of hurdles, the SBA will also pull the personal credit scores from the credit bureaus for any shareholder (or other owner) holding 20% or more ownership stake in the business.  If your credit score is low, it’s unlikely you will be approved for the EIDL loan.

You will also have to prove your identity with a valid photo ID and provide the SBA with a cancelled check for the business.  They will verify the bank you’ve identified to receive your EIDL grant and/or loan proceeds is a legitimate business bank account.  There was a lot of fraud in the EIDL first round so the SBA is being extra cautious — which is a good thing.  

 

SBA Restaurant Revitalization Funding is Now Available

SBA Restaurant Revitalization Funding is Now Available

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SBA Restaurant Funding

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On Monday, May 3rd, 2021, the Small Business Administration (SBA) opened its application portal for the Restaurant Revitalization Funding (RRF) to certain restaurants, bars and other similar businesses that serve food and/or drink which have suffered a reduction in revenue in 2020 when compared to 2019 as a result of the pandemic.

Similar to the Paycheck Protection Program Loan (PPPL) program, this federally-funded program is intended to provide cash to businesses which have suffered revenue losses and if spent on the proper types of expenses within a specific period of time (the Covered Period), the loan may be fully-forgiven by the SBA.

Restaurant Revitalization Funding Eligibility

There are several knock-out provisions to ensure those businesses awarded the RRF are truly those the funding is intended to assist.

To be eligible for the RRF, the applicant must be able to prove its 2019 on-site sale of food and drink to the public was at least 33% of its total revenue. There are also provisions for businesses which began operations between January 1st, 2020 and March 10th, 2020 to benefit from the RRF.

Other applicant knock-outs for this program include:

State or Local government operations
Permanently closed businesses or those in Chapter 7 Bankruptcy
Chapter 11, 12 or 13 Bankruptcy, and not operating under a approved plan of reorganization
Own or operate as of 03/13/2020 more than 20 locations (including affiliated businesses)
Received a Shuttered Venues Operators Grand or have a pending application
Non-profit businesses
Publicly traded businesses
Certain Franchises under the provisions of 13 CFR 120.110

Similar to the PPPL and Emergency Economic Injury Disaster Loan (EIDL) SBA programs, the RRF applicants will be required to make a good faith certification that current economic uncertainty makes the funding request necessary to support the ongoing or anticipated business operation.

The Restaurant Revitalization Funding Covered Period

The funds made available through the RRF must be used for defined eligible expenses between February 15, 2020 and the earlier of the date the business may close permanently or March 11, 2023. This timeframe is the SBA’s definition of the Covered Period for the RRF program.

Given the fact that the SBA has provided for a retroactive covered period, it’s clear it intends to help businesses in the food and beverage industry to not only revitalize, but to also to restore their vendor relationships. It’s also important to understand that there is required interim SBA reporting regarding how the RRF funds are being spent.

Restaurant Revitalization Fund Eligible Expenses Include:

Payroll costs;
Business mortgage, rent, debt service, utilities payments;
Maintenance expenses;
Outdoor seating construction costs;
Business supplies;
PPE and cleaning products;
Products sold to customers (food items and supplies);
Raw materials to make beer, wine or spirits; and
Ordinary business operating expenses.

How Much Funding is Available to my Restaurant or Bar?

If your restaurant, bar or other qualified business was in operations before January 1, 2019, the calculation of the amount of your RRF funding is fairly straight forward. To be considered a business in operations, the business must have started making sales. It’s not sufficient for the business entity to have only been formed by filing with the state corporation office.

In this case, take the business’ gross revenue for each of its physical locations in 2020 and subtract it from the gross revenue in 2019. If that figure is positive, your business suffered a reduction in sales when comparing 2020 to 2019. Take that figure and subtract any amounts you received from the PPP Loans. Subtract both draws you may have received from the PPP Loan program.

If the end result is greater than $1,000 or less than $5,000,000, your business is eligible for the Restaurant Revitalization Funding program.  If the amount is greater than $5,000,000, your RRF amount will be capped at $5,000,000 per location with a maximum of $10,000,000 per applicant (and its affiliates).

If your business had multiple locations, had not opened for business prior to January 1st, 2019, or started operations between January 1st 2020 and March 10th, 2020, there are other ways to calculate your business’ eligibility for the RRF. These calculations are found in the RRF application.

How to Apply for the Restaurant Revitalization Funding

If your business works with one of the two designated SBA Point of Sale Restaurant Partners Square or Toast, they will be able to assist you with your RRF application.

If not, you will need to have your business 2019 federal tax returns completed along with documentation to support your 2020 business gross revenue. Then go to restaurants.sba.gov to apply.

If you are not able to access the internet, you may apply at 844 279-8898.

SBA Allocation of Funding for the RRF

The SBA has set aside $9.5 Billion for this program and has offered an early window for businesses more than 50% owned by women, veterans and/or socially and economically disadvantaged individuals.

All eligible applicants may apply now. However, the SBA distribution of funding will be prioritized as follows:

The first 21 days (May 3 through 24, 2021), the SBA will distribute those who certify their business is more than 50% controlled by women, veterans or socially and economically disadvantaged individuals.

After May 24, 2021, the SBA will distribute funds in the order in which applications are approved.

The Restaurant Revitalization Funding program offers restaurants, bars and other food and beverage business owners more than a lifeline to stay open. It’s an unusual opportunity for any qualified business owner to rethink how they can move forward. Many business owners in this industry were able to pivot during the pandemic and for those who’ve survived, they may now have some real dollars to assist them in the long term. They may even thrive in our collective economic recovery.

SBA Expands PPP Loan Requests to Schedule C Filers

SBA Expands PPP Loan Requests to Schedule C Filers

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SBA Opens PPP Loans to Schedule C Filers

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In early March, the SBA announced it was halting the processing of PPP Loan Draw 2 applications for applicants with more than 20 employees for a two week period.  During that time it was providing exclusively to businesses with less than 20 employees to process their PPP Loan applications. The two week period started on Wednesday, February 25th and ends on Tuesday, March 9th, 2021.  

This was welcome news for many small business owners.  

And in the middle of the two-week exclusivity period for small business owners applications — on March 3, 2021 — the SBA released its latest ‘Interim Final Rule’ covering the new way business owners who operate as a sole proprietorship or single member LLC and prepare their federal taxes using a Schedule C may calculate their PPP Loan request.  

The changes were significant and meant that most Schedule C filers will be eligible for substantially more PPP Loan proceeds.  

Up until now, the PPP Loan proceeds for Schedule C filers was based on the 2019 net profit (referred to as the net earnings from self employment) plus payroll costs if employees worked in the business.  The Interim Final Rule (IFR) effective on March 3, 2021 allows a business owner to use either their gross income or net income as the basis to compute its PPP Loan request amount.

According to the SBA’s latest IFR, “the change is meant to help business owners who report their income and expenses on a Federal Schedule C meet its fixed expenses so they may stay in business and keep the owner employed”.

The new rules only apply for a borrower whose PPP Loan has not been approved as of the effective date of the IFR, on March 3rd, 2021.

Regardless of the number of employees a business employs, the SBA PPP Loan applications will close on March 31, 2021.

As of the date of this writing, less than three weeks remain for small business owners to digest the latest IFR and prepare their PPP Loan application which is a tall order.  Many business owners will need the assistance of their tax preparers to ensure they’ve applied in an accurate manner and it’s the middle of tax season crunch time!  

For these reasons, there are many organizations and taxpayers alike, pleading with congress and the SBA to extend the PPP Loan application deadline beyond March 31, 2021. 

How to Calculate your PPP Loan request under the latest IFR depends on whether your business has employees or not.

How to Calculate your PPP Loan Request if you Do Not Have Employees

You may use your Federal Schedule C from 2019 or 2020.  It’s your choice.

You may choose your line 31 Net Profit Amount or line 7 Gross Income Amount, as long as the amount you choose does not exceed $100,000.  

If both gross income and net profit are zero or less, you may not apply for the PPP Loan.  

Divide the amount you choose to use by 12 and then 

Multiply that amount by 2.5.  The result may not exceed $20,833.

Add any amount of EIDL made between January 31, 2020 and April 3, 2020 you want to refinance.  This EIDL program is not the EIDL Covid 19 Loan program.  The EIDL Covid 19 Loan program is not eligible for refinancing in the PPP Loan program.

The documents required to substantiate the PPP Loan request include the 2019 or 2020 Federal Schedule C, any IRS Form 1099-MISC received which were reported on the Schedule C, and records that indicate you were self-employed such as invoices, bank statements, accounting records, etc.

You will also need to provide documentation to substantiate you were in business on February 15, 2020.  Again, an invoice or bank statement covering this period should be sufficient.

 

How to Calculate your PPP Loan Request if you Have Employees

 

You may use either Federal Schedule C from 2019 or 2020.  Again, it’s your choice.

Take your Gross Income (line 7) and subtract:

Employee Benefit Programs (line 14)

Pension or Profit Sharing Plans (line 19)

Wages (line 26)

Take this sum and compare it to $100,000.  If it’s more than $100,000., your maximum PPP Loan Request amount is $20,833 ($100,000 / 12 months x 2.5).  If it’s less than $100,000, carry forward that amount to the next step.

Compute your employees total payroll costs:

To do so, remove any payroll, employee benefits programs payments and pension or profit sharing plan payments made by the business for the business owner’s benefit.

Add the amount carried forward above to the employee total payroll costs.  Divide this amount by 12 and then multiply it by 2.5.  The amount may not exceed $20,833., which is the maximum amount of PPP Loan request available to a Schedule C filer under the new IRF.  

The documents required to substantiate the PPP Loan request are the same as noted above for the Schedule C Filers who do not have employees, with one exception.  The applicant will have to submit its federal quarterly form 941 and state quarterly unemployment tax returns or its payroll processor records, health insurance and retirement plan paid invoices as well.

Other PPP Loan Applicant Changes for Self Employed Schedule C Filers

In addition to changes to how a Schedule C filer calculates their maximum PPP Loan request, the IFR removes two other barriers for small business owners.  The IFR waives the restriction that prevented business owners with non-financial fraud felony convictions in the last year as well as business owners who were delinquent or in default on their federal student loans from applying for the PPP Loan.  

 

SBA Reopens Economic Injury Disaster Loan Applications

SBA Reopens Economic Injury Disaster Loan Applications

by | Business Capital | 2 Questions

EIDL Available Now

On June 15, 2020, the Small Business Administration reopened the Economic Injury Disaster Loan (EIDL) applications to businesses with no more than 500 employees and non-profit organizations operating and suffering substantial economic injury as a result of the pandemic in all of the U.S. states, Washington D.C., and territories.  

Independent Contractors, sole-proprietors (with or without employees), gig workers and freelancers are also eligible to apply for the EIDL.  

To be eligible for this loan program, you must have been operating your business on January 31, 2020.

In April of this year, applications for the EIDL program were closed, which forced most small businesses and non-profits to rely solely on the Paycheck Protection Program Loan (PPPL) for economic assistance.  

 

What Can the EIDL be Used For?

 

The EIDL proceeds are intended to help businesses and non-profits meet their ongoing working capital needs.  The money may be used to cover expenses and debts not already covered by the PPPL.  Those expenses include expenses such as:

Commercial Loan Payments

Payroll Costs

Trade Accounts Payable

It is possible to receive an EIDL and a PPPL, however keep in mind that you can not double-dip by using the proceeds from the EIDL and PPPL loans to cover the same expenses.  

 

PPPL vs EIDL

 

Unlike the PPPL, the EIDL is not eligible for repayment forgiveness.  Instead, its repayment terms may be extended to up to 30 years, includes a one-year payment deferral and is offered at a guaranteed low annual interest rate of 2.75% for non-profit organizations and 3.75% for small businesses.

Also unlike the PPPL application process, applying for the EIDL is simple and takes no more than ten-to-fifteen minutes.  The application is made by the business or non-profit via an online application directly on the SBA’s website.  No need to beg your SBA-approved bank or other lender to review and process your loan application!  

 

EIDL Grant Calculation

 

The EIDL will advance applicants a grant amount up to $10,000 based on the number of full-time employees on their payroll as of January 31, 2020.  For every employee on the payroll on January 31, 2020, the business will receive $1,000 up to the $10,000 cap.  This advance amount is considered to be a grant and will not need to be repaid, unless the applicant also received PPPL funds.  In such a case, the EIDL grant amount will be regarded as a non-forgiven loan in the PPPL and subject to the PPPL repayment terms.  

For those applicants who are not considered to be a business entity, the EIDL grant will be capped at $1,000., unless there are employees on its payroll.   In such a case, the total number of employees multiplied by $1,000, up to the $10,000 cap will be received as a grant.  

 

EIDL Application, Collateral & Personal Guarantees

 

The owners of the business applying for the EIDL will be required to provide the SBA and the lender with their personal information, including birthdate, birthplace, home address, phone numbers, citizenship status and social security numbers.  The SBA will determine if the applicants are credit worthy before an Economic Injury Disaster Loan is offered to them.  And the applicant is not obliged to accept the EIDL if it is offered to them.

If your business receives an EIDL in the amount of $25,000 or less, you will not be required to put up collateral as security.  And personal guarantees, which are typically required to get an SBA loan funded, will be waived for loans up to $200,000 through December 31, 2020.  

 

Conclusion

 

At the time of drafting this post, the SBA has not released the maximum amount of EIDL proceeds to be made available to applicants.  Certain reports indicate it may be $150,000 and while other reports indicate the cap may be as high as $2,000,000.  

Given the current uncertain economic circumstances, it is reasonable to consider applying for the Economic Injury Disaster Loan before the SBA closes the application window again.  Doing so may provide a source of cash otherwise not available.

7 Changes PPP Loan Flexibility Act Offers Business Owners

7 Changes PPP Loan Flexibility Act Offers Business Owners

by | Business Capital | No Q&A Yet

PPP Loan Flexibility Act

On June 5, 2020, President Trump signed into law the Paycheck Protection Program Flexibility Act (PPPFA), which is the latest attempt to save struggling businesses from permanent shutdown.   

The Flexibility Act offers business owners seven significant changes to the original Paycheck Protection Program (PPP) Loan terms.  The House and Senate were driven to make these changes due to the lengthy pandemic and the fact that many PPP Loan recipients have not been able to re-open their doors for business during the required eight-week ‘covered period’ set forth in the original PPP Loan Act.  

The PPP Loan Flexibility Act will make it much easier for business owners to achieve full, or nearly full, loan forgiveness.  

The new law provides business owners with seven significant changes to the original law and those include:

 

1. The Eight-Week Period is Extended to 24-Weeks to spend the PPP Loan Proceeds

 

This change is optional for business owners.  If they’d prefer to stick with the original eight-week covered period when they apply for loan forgiveness with their bank, they may choose to do so.  

In certain cases, it may make more sense to use the original eight week period when applying for the loan forgiveness.  Such a case may be when the business already spent the proceeds on payroll costs while its doors were closed and are now still unable to cover payroll and operating costs moving forward.  The business may be closing altogether.

Because the business owner will need to comply with the original requirement that the employee headcount (or FTEs) may not be reduced by more than 75% during the covered period (or qualify for the June 30, 2020 exception), using the original eight-week period   will allow for the forgiveness of payroll costs.

 

2. The Requirement to Spend 75% of the PPP Loan Proceeds is Reduced to 60%

 

This change is good for all PPP Loan recipients because the original requirement to reach the 75% payroll costs threshold required many business owners to pay employees who were not  working at all or were working fewer hours during the covered period.  It also forced many business owners to pay employees one-time bonuses.  

It’s important to note that the current law states that the 60% payroll cost threshold is treated as a cliff.  There is no loan forgiveness pro rata calculation permitted in the new PPP Loan Flexibility Act if an employer does not pay the minimum 60% payroll costs to its workforce.  As with the PPP Loan Act where many changes were made through the SBA’s Final Regulations, this too may change.  

 

3. The June 30, 2020 Deadline to Restore Workforce is Extended to December 31, 2020

 

In the original law, employers were able to use one of the exceptions to the FTE Reduction rules and had until June 30, 2020 to restore its workforce to pre-pandemic levels.  The Flexibility Act now extends this exception all the way out to December 31, 2020.  

 

4. Forgiveness is Available if Unable to Find Qualified Employees

 

The new law recognizes that for many employers, finding qualified employees during the continuing pandemic can be difficult.  

 

5. Forgiveness is Available if Unable to Restore Operations Due to Pandemic Restrictions

 

For many businesses, it’s been difficult, and in some cases impossible, to re-open their doors for business.  This is particularly true in the hospitality industry where  current state mandates severely restrict occupancy.  And without normal occupancy levels, it may not be possible for the business to open, operate, and / or  breakeven.  

 

6. PPP Loan Repayment Term may be Extended from 2 Years to 5 Years

 

With the approval of the employer’s SBA Lender, the original two-year loan term may be extended to up to five years.  

 

7. PPP Loan Recipients may Choose to Delay Federal Payroll Tax Payments

 

The original PPP Loan terms were part of the CARES Act, which included a provision for employers to delay payment of their share of federal social security (FICA & MEDICARE) taxes.  The CARES Act did not allow a PPP Loan recipient to take advantage of this provision.  

The PPP Loan Flexibility Act now allows business owners to take advantage of this provision.  

 

Conclusion

 

While it would be great to conclude the PPP Loan Flexibility Act is the final chapter in the pandemic economic mitigation financial aid packages, I truly doubt this is going to be the case.  

As with the Paycheck Protection Program Loans, there were many revisions.  I expect this will be the case for the PPP Loan Flexibility Act as well.  So, stay tuned.

In the meantime, it’s best to revisit your PPP Loan Forgiveness calculations to learn if any of the changes outlined above will help you and your business.

 

PPP Loans Out of Money — What To Do Now?

PPP Loans Out of Money — What To Do Now?

by | Business Capital | 5 Questions

The Small Business Administration announced on Thursday, April 16th all federal funds set aside for the Paycheck Protection Plan (PPP) Loans have been allocated to those business owners who were persistent (and fortunate) enough to get through the application process and receive an official registration number from the SBA via its bank.

In simple terms, the PPP Loans are out of money to assist business owners.

On April 3rd, the PPP Loan application process was opened by the SBA and in less than two weeks no less than $349B was committed to be delivered to small business owners to assist them

For those business owners who have received (or will be receiving) their PPP Loan proceeds, their attention is now shifting to understanding how to apply for the loan forgiveness.  At this point in time, there is very little guidance on exactly what the SBA and the banks that have lent the PPP Loan funds will be looking for.  As this information is released by the SBA and lending institutions, another post will be added to the site to help business owners prepare.

According to the SBA, when it met its $349B lending limit on Thursday, 1.6 million small business owners received the SBA’s loan commitment registration number.  With more than 30 million small businesses in America, the $349B cap leaves a very wide gap between those businesses that will receive financial help to meet payroll over the next two months and those without a financial lifeline.

So, if your business is in the majority, what do you do now?

4 Steps to Take Now if Your Business Did Not Receive a PPP Loan

1. Call your U.S. House of Representative and voice your concerns and insist they take care of those business owners who are struggling to stay in business. Here’s where you may find your Representative.
2. If you’ve submitted your application through your business bank, confirm its status. Ask them if it’s been submitted to the SBA and if so, has an SBA registration number been issued. If so, your loan is earmarked for funding already and your bank should be initiating the loan’s promissory note soon.
3. If you have not submitted your application yet, prepare all required documents to do so and find a bank that is still accepting applications. That’s not easy to do as many of the banks have simply stopped taking the applications. That said, if congress extends the PPP Loan funding beyond its initial $349B, you will be ready to apply.

Here’s what you need to gather:

  • Last 12 months payroll reports showing the gross payroll for every employee
  • Federal Form 941 reports for the last four quarters
  • Paid Group Health Insurance Premium Invoices
  • Paid Retirement Fund payments the business made for the employees (do not count the amounts withheld from employees’ payroll checks, only count the amounts the business paid.
  • If self-employed and you report your income on a Federal Schedule C, find that tax form for 2019.  It will be the basis of calculating your average payroll costs for the PPP Loan application.

    Unfortunately, every lending institution has its own way of gathering the documents its requiring to process applications for the PPP Loans, so be mindful of this fact.  And going into it with a good healthy serving of patience will be helpful.

4. If your business bank is either not an authorized SBA Lender or has shut down its PPP Loan application processing, find another bank. Start with the bank you bank with personally.  Call them and explain the situation.  Many of the smaller, community banks are eager to work with business owners at this time of crisis in order to grow their market share.

It’s not clear if Congress will approve additional funds for the PPP Loans.  If so, the same crazy application frenzy will repeat.  Next time around, don’t be caught flatfooted.  Prepare now.

How the Paycheck Protection Loans Work

How the Paycheck Protection Loans Work

by | Business Capital | 90 Questions

 On Friday, March 27, 2020, the Paycheck Protection (Loan) Program (PPL) for small businesses was approved as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  This new law is intended to help small business owners in an unprecedented way. 

On June 5, 2020, the Paycheck Protection Program Loan Flexibility Act was signed into law and loosened the rules for business owners to qualify for loan forgiveness.  This post has been updated to reflect these changes.

First, while the Paycheck Protection Program Loan will be initially set up by banks and approved by the SBA under section 7 (a), unlike other SBA loan programs, the PPL is guaranteed 100% by the SBA.

Second, if the proceeds of the loan are used by business owners as Congress, the Senate and President Trump intended, the loan will be forgiven.

Essentially, how the paycheck protection loans work for small business owners depends on whether loan proceeds are used properly.  If so, the loan becomes a grant from the federal government to help you get your business back in business as soon as possible.

In this post, we will cover the following about the Payroll Protection Loan program:

  • How to qualify for the Paycheck Protection Loan?
  • What type of Employees are eligible for the PPL?
  • How much is the maximum amount of PPL available for my business?
  • What’s included in Payroll Costs when calculating the maximum PPL?
  • Which Payroll Costs do NOT qualify for the PPL?
  • What can I use the loan proceeds for?
  • What’s the Recipient Good Faith Certification?
  • Do I have to personally guaranteed the PPL?
  • What are the costs associated with the PPL?
  • When do I have to start making PPL payments?
  • How do I get PPL forgiveness or make the PPL a Grant?
  • How do I apply for a Paycheck Protection Loan for my business?

 

How to qualify for the Paycheck Protection Loan

 

In order to qualify for the PPL, the business must have been in operation on February 15, 2020 and had employees being paid wages, salary and payroll taxes OR paid independent contractors and reported those payments on federal form 1099-MISC.

 

What type of Employees are eligible for the PPL

 

The PPL eligible business may not have employed more than 500 employees as of February 15, 2020.  The term employee includes individuals who work on either a full-time or part-time basis.

 

The Accommodation and Food Services businesses may measure the employee count based on each physical location.

 

And for those individuals who operate their business as sole proprietors (filing a tax return on a Schedule C) or as a self-employed business owner, they also may be eligible to receive a Paycheck Protection Loan.

 

How much is the maximum amount of PPL available for my business

 

During the period from February 15, 2020 and ending on June 30, 2020, the maximum PPL amount is the LESSER of:

  • The AVERAGE TOTAL MONTHLY PAYMENTS by the business owner for PAYROLL COSTS incurred during the one-year period before the date on which the loan is made MULTIPLIED BY 2.5;
  • PLUS any outstanding loan amounts that were made beginning on January 31, 2020 and ending on the date the business owner receives the PPL, which may be eligible to be refinanced under the PPL

OR

  • $10,000,000.

What’s included in Payroll Costs when calculating the maximum PPL

 

Under the Paycheck Protection Loan Program, Payroll Costs include the following:

  • Salary, Wages, Commissions and similar forms of compensation;
  • Payment of cash tips or equivalents;
  • Allowances for dismissal or separation payments;
  • Payment of vacation, parental, family, medical or sick leave;
  • Group Health Care Benefits, including insurance premiums;
  • Retirement Benefits paid by the employer;
  • State and Local Taxes assessed on employee compensation paid by the business;
  • The sum of payments of any compensation to or income of a Sole Proprietor or Independent Contractor that is wage, commission, income, net earnings from self-employment or similar compensation and that is in an amount not exceeding more than $100,000 in one year, as prorated for the period beginning on February 15, 2020 and ending on June 30, 2020.

Which Payroll Costs do NOT qualify for the PPL

 

Under the Paycheck Protection Loan Program, Payroll Costs do NOT include the following:

  • the compensation of an individual employee in excess of an annual salary of $100,000 as prorated for the period beginning on February 15, 2020 and ending on June 30, 2020:
  • taxes imposed or withheld under FICA (Social Security and Medicare), Railroad Retirement Act, and IRC Chapter 24;
  • any compensation of an employee whose principal place of residence is outside of the United States;
  • qualified sick leave or family leave wages for which a credit is allowed under the Families First Coronavirus Response Act. (This means business owners can’t double-dip).

What can I use the loan proceeds for

 

The business owner who receives a Paycheck Protection Loan may use the proceeds between February 15, 2020 and June 30, 2020 for:

  • payroll costs;
  • any costs related to continuing group health care benefits;
  • employee salaries, wages, commissions or similar forms of compensation;
  • rent payments;
  • utilities;
  • interest payments on any mortgage obligation;
  • interest on any other form of debt obligation that was incurred before the period.

What’s the Recipient Good Faith Certification

 

In order to obtain the PPL, the business owner will be required to sign a certification stating the reason for the loan is related to the uncertainty of the current economic conditions, confirming they don’t have another loan application pending for the same purpose, acknowledging the funds will be used to retain workers and maintain payroll, meet mortgage, rent and utility obligations, and during the period beginning on February 15, 2020 and ending on December 31, 2020, they’ve not received loan proceeds under the PPL for the same purpose.

Do I have to personally guarantee the PPL

 

No.  The Paycheck Protection Loan Program does not require the business owner to personally guarantee the loan.  And there are no collateral requirements either.

The SBA will have no recourse against any individual shareholder, LLC members or partner of the business receiving the PPL proceeds for nonpayment unless the loan proceeds are not used for the authorized purposes.

What are the costs associated with the PPL

There are no fees whatsoever to the business owner for the Paycheck Protection Loan program between February 15, 2020 and June 30, 2020.

 

When do I have to start making PPL payments

The PPL has a loan payment deferral of not less than six months and not more than one year between February 15, 2020 and ending on December 31, 2020.

 

However, if the loan proceeds are used as the PPL program intended, the PPL may be forgiven and converted to a grant.

 

How do I get PPL forgiveness or make the PPL a Grant

 

If the business owner spends the loan proceeds on certain expenses during the eight weeks following receipt of the loan, the loan will be forgiven.

The expenses that will qualify for loan forgiveness include the following:

  • Payroll Costs as defined above;
  • Interest payments on mortgage obligations of the business incurred before February 15, 2020;
  • Rent payments made under a lease agreement in existence before February 15, 2020;
  • Utility payments (electricity, water, gas, transportation, telephone, internet access which service began before February 15, 2020

How do I apply for a Paycheck Protection Loan for my business

 

The SBA has established the procedures for business owner applicants to go through their local banks which are authorized as an SBA lender.

Small Business Financing

Small Business Financing

by | Business Capital | No Q&A Yet

small business financingWithout cash flow, a business cannot pay its employees, make debt payments, or invest in its future growth – making cash flow a critical focal point in every business, regardless of size. Yet searching for the correct small business financing can be overwhelming, especially for the first time borrower.

Today, small business owners have a number of options when it comes to obtaining financing to start or grow their business. Technology has offered entrepreneurs additional options for those in need of small business financing. But this has not always been the case. In years past, small business owners had very few options when it came to obtaining funding. The traditional way was to to apply for a bank loan which often was not approved.

The world has changed since the Great Recession and so has the small business financing sector. Prior to then we saw a rise in factoring and Merchant Cash Advances. Since the Great Recession an “alternative” lending space has evolved rapidly. In this post we cover some examples of small business financing options, both traditional and alternative.

Debt vs. Equity Financing

It’s important to understand that financing can be obtained in one of two ways: through debt (like a loans or other type of credit which must be repaid, usually with interest), or equity (issuing ownership in the business in exchange for financing). You can learn more about debt vs. equity financing here.

Amazon’s Alternative Lending Program

If you’re an aspiring entrepreneur in need of small business funding, you may want to consider selling your products through Amazon.com. According to the Wall Street Journal, Amazon Capital Services, Inc (a division of Amazon.com), has rolled out an alternative lending program for merchants who sell products through their marketplace.  This gives entrepreneurs who may not be able to qualify for small business funding through traditional lenders an opportunity to fund their business using a viable alternative capital source.

Accounts Receivable Financing

Sometimes your customers simply don’t pay you soon enough while your employees, their payroll taxes and other vendors must be paid on a timely basis!  If your business hasn’t been established or had a bad year, most banks and other lenders may turn you down for a line of credit.  In such cases, obtaining cash based on your existing Accounts Receivable may be a good option for you.

Credit Cards

Business credit cards are an easy way to obtain credit for your small business, and make it easy to track expenses while earning rewards for business expenses. It’s important to research several options before choosing the right fit, considering things like credit limits, rewards programs, fees, and of course, interest rates. Choosing a good fit could mean saving thousands of dollars a year in interest expenses and fees.

Bank Lending

Banks and credit unions offer term loans, which are best-suited for long-term financing needs (in other words, if a business owner needs to finance the purchase of an investment or asset). In order for a business owner to qualify for a small business loan from a bank, they usually will  need to meet minimum cash flow and collateral requirements, and have a good personal credit score.

For short-term needs, small business owners may consider a Line of Credit (LOC). These revolving loans make cash available on an as-needed basis, and can be used to cover working capital needs, like meeting payroll or paying invoices.

Crowd Funding

For business purposes, crowd funding is the practice of raising funds from donors for the purpose of launching or growing a business. This fundraising practice has been increasing in popularity in recent years, and generally obtains donations via websites like GoFundMe or Kickstarter.

Loan Programs

Outside of small business loans granted by banks and credit unions, there are also other loan programs. These loan programs make financing available where it might otherwise be difficult or impossible for an entrepreneur or small business owner to obtain funding.

SBA Loan Programs

For example, the Small Business Administration (SBA) Loan program is ideal for businesses which do not meet the cash flow and collateral requirements for a traditional bank loan.

This program allows the SBA to provide a guarantee to the lending bank for the funds it lends to small business owners, which in turn reduces the risk for these banks. It is important to understand that SBA loans are not granted directly by the SBA, but instead by SBA-approved banks and financial institutions.

Learn more about SBA loans and other types of business lending here.

Venture Capital

Venture capital is another popular method of obtaining funding, particularly for startups. Venture capital is a type of private equity, which is provided by venture capital firms to small businesses or startups that are believed to have high long-term growth potential. Venture capital firms evaluate the business model and the management team’s ability to scale-up with the assistance of its capital, advice, and business connections.

While venture capital can be a good fit for some businesses, it’s important to keep in mind that it’s not always the right choice for every business. If a deal seems to good to be true, it probably is. Be sure to take time to evaluate any venture capital offer and ensure that it makes good common sense!

Private Equity Groups

Today, there is an abundance of Private Equity Groups (PEGs) with capital to invest in growing, profitable, well-established businesses.  

Private Equity firms typically seek businesses that demonstrate the ability to produce multiple years of EBITDA in excess of $500,000 (and some require much higher level of EBITDA).  They also usually seek businesses which may complement other businesses they hold in its investment portfolio.

While some Private Equity Groups desire 100% ownership in its investments, many more desire continued ownership by the founder once the investment is made.  The opportunity for a business owner to sell some or most of his/her equity now and then sell the remaining equity later, once additional growth in its value is achieved, is what makes sourcing Private Equity Group capital so interesting for many business owners.  

Taking an investment from a Private Equity Group to grow a business, means the business may also benefit from the PEG’s investors, leaders and managements’ technical abilities, business acumen and connections.

Not all Private Equity Groups are alike.  Each has its own unique set of investment criteria and goals.  For the business owner who is considering a partial sale of equity to this type of capital source, careful evaluation should be made.

Angel Investor

High net worth individuals (HNWIs) who invest in startups and high-growth small businesses (usually in emerging industries) are often known as ‘angel investors’. Angel investors are wealthy individuals who invest in high-risk, high-reward businesses based on their personal interests and beliefs about the business’ likelihood to succeed. Angel investors may come from a variety of backgrounds, and may have achieved wealth from a number of different sources, but often are entrepreneurs themselves.

In conclusion, if you are an entrepreneur or small business owner in need of funding, be sure to research your options so you can make the best decision for your personal circumstances and your business. Although it’s never been an easy proposition, there are more funding options available for your small business than ever before.

Business Lending

Business Lending

by | Business Capital | 3 Questions

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 Business LendingBusiness Lending from Banks

 

Whether you’re a Main Street small business, an Entrepreneur growing a business from start-up, or a Middle Market Business about to embark on an Initial Public Offering (IPO), chances are you’ve had to turn to your local or regional bank or credit union to borrow business capital. And chances are you’ve learned these business lending institutions make their decisions based on what is known in the industry as the three C’s of lending:

Cash Flow

Collateral

Credit History (or Credit Score)

Now in recent years, commercial banks and credit unions have tightened up their lending/loan criteria to the degree that obtaining business loans is restricted only to those businesses with a proven track record of profitability. Of primary importance is the financial performance of the business over the last two years.  What also serves a guidepost for lenders is the underlying credit score of the business owner(s).  Without a good personal credit score, certain lenders will simply opt out or decline the loan request. In such cases, the business is forced to seek alternative lending companies at a higher cost of capital.

Long Term Financing

Bank and credit union term loans are best suited to permanent financing needs. In other words, if an entrepreneur needs to finance an asset or investment with a useful life of several or more years, term loans are most appropriate. Similarly, if a loan is needed to finance an improvement to real property then a longer term loan of ten years or more is advisable.

Short Term Financing

Banks and credit unions also offer qualified businesses a Line of Credit (LOC) to meet short-term or day-to-day cash needs. Such operating funds, made available through a line of credit, allow the entrepreneur to pay his trade invoices and to meet payroll while waiting for his customers/clients to pay their invoices. Without a business line of credit, most businesses, small and large alike, would be forced to close their doors. Lines of Credit are in many cases secured by and tied to trade Accounts Receivable and in certain cases Inventory.

SBA Business Lending

When a business does not meet the Cash Flow and Collateral requirements to qualify for a loan, a Small Business Administration (SBA) Loan may be offered. In such a case, the bank makes the loan to the business and the SBA stands behind the bank to guarantee a portion of the loan in case of default.

What is an SBA Loan?

It is important to understand that SBA loans are not granted directly by the SBA to borrowers to start, acquire or grow a business. Instead, the SBA provides a guarantee to bank for the funds it lends to small business owners. For the lending institution this reduces the risk associated with lending to small business owners, and for entrepreneurs it creates  financing opportunities for businesses that may not qualify for traditional loans.

The interest rate that is charged on an SBA loan is based on the prime rate. The SBA can’t set the interest rates; however, it does regulate the amount of interest that a financial institution may charge an SBA borrower.

Generally, SBA guaranteed loans and granted by a private lender, and are backed up to 80% by the SBA. This both reduces risk to the lender, and makes reasonable loans available to businesses that would otherwise struggle to obtain affordable financing. Keep in mind that your business will need to qualify as a small business based on standards created by the SBA.  

What Types of SBA Loans Are Available?

SBA programs vary depending on the needs of the borrowing business . There are loans designed for everything from working capital and growth capital to disaster recovery. Below, we’ll outline some of the most popular SBA loan programs.

7(a) Guaranteed Loan Program – This is the most common business loan offered by the SBA. Called the 7(a) General Business Loan Guarantee Program, this loan can be used for a variety of purposes to support the various short and long-term needs of startups including: working capital, revolving funds, refinancing existing debt, equipment purchases, real-estate purchases, and more.

7(a) General Business Loan Guarantee Program loans are generally guaranteed up to $750,000, with 80% being guaranteed on a loan $100,000 or less and 75% for loans over $100,000.

Businesses will need to post collateral in exchange for the loan, just as they would for a traditional loan. Collateral may be accepted in the form of:

  •      Stocks and bonds
  •      Savings accounts
  •      Accounts receivable
  •      Life insurance policies
  •      A person who is capable (and willing) to take responsibility for the loan balance in the event of default.
  •      Real estate
  •      Machinery and equipment
  •      Land

504 Local Development Company Program – This is a long-term, fixed-rate financing SBA loan designed specifically for the purposes of obtaining machinery, equipment, or real estate. These loans are offered by Certified Development Companies (CDCs) and are typically financed 50% by the bank, 40% by the CDC, and 10% by the business.

These loans require that businesses meet certain public policy goals (like creating or retaining jobs) in an exchange for below-market, fixed-rate financing.

Microloan Program – This loan is designed to assist businesses who seek to borrow less than $25,000 in working capital with the purpose of purchasing supplies, inventory, furniture, equipment, and machinery. This loan is unique because it allows a small business to borrow an amount that would otherwise be too small for a traditional business loan.

Microloans are offered via non-profit and community-based organizations, who have been approved as SBA Microloan lenders. These approved organizations receive long-term funds from the SBA, and then make smaller, shorter-term loans available to small business owners in their communities.

Disaster Loans – These are available to homeowners, businesses, and renters, and may be used to restore, repair, and replace assets and real estate that have been destroyed in a natural disaster.

State Business and Industrial Development Corporations (SBIDCs) – These loans are capitalized through state governments, and may fund very high-risk ventures, or low risk ventures, depending on the SBIDC. These are long term loans (5-20 years), intended for the expansion of a small business or the purchase of equipment.

CDC-504 Loans – These loans offer fixed-asset financing through CDCs (Certified Development Companies), which are nonprofit corporations  sponsored by private-sector organizations or state and local organizations that contribute to economic growth.

Energy and Conservation Loans – These loans are specifically designed to support small businesses that contribute to the conservation of the nation’s energy resources.

The Export-Import Bank (EXIMBANK) and The Export Working Capital Program – These programs (sometimes referred to as an export-assistance loan) offers opportunities for small companies to finance foreign marketing opportunities, such as exports.

SBA Express – SBA Express loans are offered for businesses who need an accelerated turnaround time for an SBA loan approval. These loans promise that a response to an application will be given within 36 hours.

Community Adjustment and Investment Program Loans – These loans are designed to create new sustainable jobs as well as maintain old jobs that are at risk as a result of changing trade patterns with Canada and Mexico.

The Small Business Innovation Research Program (SBIR) – This program is intended for American-owned small businesses with fewer than 500 employees, providing these businesses access to more than $1 billion in federal grants and contracts.

Who Can Fund SBA Loans?

SBA loans may be funded via three types of lenders: preferred lenders, certified lenders, and infrequent participant lenders. Not all banks can be certified by the SBA, as they must meet certain specific criteria. These criteria include: a minimum of 10 years SBA lending experience, an impressive SBA loan record (with very few loans being bought back by the SBA), an impressive record of loans to local borrowers (especially to minorities and women), and a record of lending to local small businesses.

Preferred Lenders – These institutions are certified lenders who have worked their way to the top of the list of SBA lenders, thanks to their superior performance. These lenders are consistently the SBA’s “best and most reliable” lenders, and as such are awarded the “Preferred” designation.

Certified Lenders – Certified lenders are institutions that are certified to award SBA loans. These institutions have staff that are trained and certified by the SBA. They decide whether or not to award the SBA loan to the borrower – however once they submit the paperwork, the SBA has the final say. The SBA doesn’t review and approve the loan until after the financial institution has already approved it.

Infrequent Participant Lenders – These institutions offer SBA loans on a sporadic basis. In these cases, the lending institution sends all the loan paperwork through to the SBA, who then completes an independent assessment, and determines whether or not to grant the loan.

Is My Business Eligible for An SBA Loan?

Your business may be considered eligible for an SBA loan assuming it’s independently owned and operated,  isn’t dominant in its field, and meets any employment and/or sales standards  required by the SBA. Loans may not be awarded to any speculative businesses, nonprofit enterprises, media businesses, amusement parks and recreational businesses, or any business affiliated with investing, lending, gambling.

Before the SBA will be willing to approve a request for funding, you’ll need to be prepared to prove that your business is  prepared to compete successfully in its industry. It’s imperative that you research and determine which field your business is best positioned to compete in, and list it as such on your SBA application. The approval on your loan may be dependent on the classification assigned by the SBA.  

Other factors that will weigh into your qualification for an SBA loan include: your business goals, how much money you plan to borrow and how much of it will go into the business, your management capabilities, your business experience, a projection of what your business will earn in the first year (particularly if you are a startup), your current personal financial position (including debts and liabilities), and the collateral you can offer as security for the loan.

Don’t be surprised if the SBA requires you to explain or prove any portion of your application. Be prepared with detailed financial (or pro-forma) statements, and keep notes on everything that you add to the loan application so that you can quickly refer to where the information originated. Additionally, as with any other major loan application, don’t make any major purchases or financial changes during the duration of the loan approval process.

What Type of Business Lending Is Right for My Business?

Deciding which SBA loan is right for your business will take some research and self-evaluation. Here are some questions the SBA suggests you ask yourself in preparation for applying for a loan:

  •      Are you having trouble paying your obligations on time? Do you need              working capital?
  •      What is the nature of your need?
  •      Are you in search of funds to launch or grow your business, or do you need       a cushion against risk?
  •      How urgent is your need for financing?
  •      What is your risk level?
  •      What will the funds be used for?
  •      Is your business cyclical or seasonal?
  •      What is the state of your business’s industry?

 

If considering an SBA Loan, you should also be prepared to pay additional fees to close the loan.  

By completing a thorough analysis of your business’ current status and needs, you’ll be adequately prepared to decide which SBA loan is an ideal fit. To learn more about what the SBA offers, visit their website: https://www.sba.gov/loans-grants.

 

Growth Capital vs Working Capital

Growth Capital vs Working Capital

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Sufficient cash, otherwise known as business capital, is necessary for any business to pay vendors and employees on time and to invest in real and intangible assets that enable growth.  That’s why, as a business owner, it’s critical to understand what business capital is, and the differences between growth capital vs working capital.

Growth Capital vs Working Capital

Business capital is available in two main forms: debt and equity. Debt instruments include term loans and other types of financing which require repayment in the future, usually with interest. Conversely, equity is normally in the form of stock and members or partners’ equity. Equity typically does not require a direct repayment of funds.

In this post, we’ll go into greater detail by discussing growth capital vs working capital, and how each form of business capital may be used most effectively to help a business thrive.

Growth Capital Definition

Growth capital is defined as flexible, long-term debt or equity that is set aside specifically for financing future growth. Growth capital is critical over the long term, and usually accumulates until the business needs it for something – like new equipment, renovations, additional locations (or moving to a bigger or better one), or other major investments and acquisitions. Growth capital can be used for any purpose that supports the growth of the business. It also affords financial stability and flexibility between rounds of financing.

Expansion Phase of the Business Cycle

The business cycle of economic growth and decline happens naturally over time. Each business cycle has four phases: expansion, peak, contraction, and trough. The expansion phase is critical to small business growth and it’s the time during which growth capital is most accessible. Business owners who are able to recognize the phases in a business cycle are better prepared to make good financial decisions regarding their company’s capital needs.

The expansion phase happens between the trough and the peak, and indicates a surge in business activity leading to growth in the economy. This means that the GDP reaches a healthy growth rate of 2-3%, unemployment is at its natural rate of 4.5-5%, and inflation is around the 2% target. When the economy is managed well during this stage, it can remain in expansion for years. The average length of an expansion phase is three to 4 years; however, they have been known to range anywhere from 12 months to more than 10 years.

It’s possible for economists to predict when an expansion is coming. They study indicators such as the availability of cash, interest rates, and the ease with which consumers and businesses are able to obtain loans to determine changes in the business cycle.

An expansion often occurs when the Federal Reserve lowers interest rates and buys back bonds, injecting cash into the financial system. Bondholders then have cash to put in the banks, and then banks have cash to lend to companies looking to expand resulting in low unemployment and increased consumer spending.

This phase comes to an end when the economy “overheats,” or the GDP growth rate surpasses 3%, inflation is greater than 2%, and investors become over-confident. This is how asset bubbles form. They will eventually burst as the economy begins to contract. The final month before the contraction phase begins is called the peak phase.

Equity Financing

Equity financing is one option for obtaining growth capital. It refers to the process of raising capital through the sale of shares (or other forms of ownership interest) in a business. Equity financing can be as small as a few thousand dollars raised from friends and family by an entrepreneur or as large as a massive initial public offering (IPO) for billions of dollars from a corporate giant. For our purposes, we’ll focus on equity financing as it applies to entrepreneurs and small business owners.

Equity capital is a popular form of financing for high risk, high return businesses and startups. Often, entrepreneurs will turn to private equity, venture capitalists (and in certain cases, angel investors) in search of funding. Business owners relinquish anywhere from 25 to 75 percent of business ownership in exchange for financing. While equity financing doesn’t require direct repayment of the funds raised, investors are entitled to a share of the profits from the business, depending on their stake. Also keep in mind that if an investor holds voting stock (or rights) they retain certain rights to influence decisions about business operations.

Debt Financing

While equity financing relinquishes ownership in exchange for cash, debt financing is the process of borrowing funds to finance your business. This is an alternative form of financing to equity and provides growth capital in the form of loans, credit cards, and other debt instruments.

Although many businesses establish a commercial line of credit (also known as a LOC) with their bank, a LOC typically doesn’t work well for a business when it is in an expansion mode. Lines of credit are meant to serve short-term, working capital needs and is explained below.

Debt financing requires the borrower to repay the funds borrowed in full in a certain time period, and with interest, according to agreed upon terms. The main advantage to debt financing is that the lender does not take an equity interest in your business, and business owners retain full ownership and control.

Keep in mind that in many cases the lender will require your business assets be posted as collateral for the loan and will insist on filing a Federal Uniform Commercial Code form (also known as a UCC-1) at the State’s Corporation Bureau or offices. This notification puts all interested parties on notice that the business has borrowed funds from the lender and the lender has secured a collateralized position against the assets identified in the UCC-1 filing, in case the business defaults on the loan terms.

Regardless of which type of financing you choose, be prepared to produce a solid business plan including financial statements, tax returns, and financial projections. You’ll be hard-pressed to find an investor or lender who will consider funding your business without full disclosure of all financial and tax matters related to the business.

Free Cash Flow Formula

Free cash flow (FCF) is a measure of a company’s financial performance and is calculated as follows:

FCF = Operating Cash Flow – Capital Expenditures

FCF represents the cash generated after a business spends the money required for it to maintain its asset base (like property and equipment). This is important because FCF is the cash available to to enhance shareholder value (or capital growth). It can be used for expansion of the business, reducing debt, paying shareholder dividends or distributions, and a number of other purposes. Increasing free cash flow is a sign of a healthy company and often occurs during the expansion phase of the business cycle.

What is Working Capital

While growth capital is cash specifically allocated for the purpose growing a business and an indication of a company’s long-term growth potential, working capital is a measure of a business’ operating efficiency and short-term financial health.

Working capital can be divided into two categories:

gross working capital (the sum of a company’s total financial resources, or assets); and
net working capital.

Working Capital Ratio

The working capital ratio is calculated as Current Assets divided by Current Liabilities, and indicates whether or not a company has enough short term assets to cover its short term debt. A working capital ratio less than one means the business has negative working capital (or is unable to pay short term debts). Anything greater than two means that the business is probably not investing excess assets (or sitting on too much cash). Most business analysts agree that a ratio between 1.2 and 2.0 is ideal.

Keep in mind that the amount of working capital that is ideal for one company may be different for another. For example, a business that is more cyclical or seasonal will likely want to have a higher working capital ratio than one that sees fairly steady business year-round.

Net Working Capital

Net working capital is calculated by taking a company’s total current assets and subtracting its current liabilities. Working capital includes cash, accounts receivable, accounts payable, inventory, employee salaries, debts due within one year, and other short-term accounts, making it a good indicator of a company’s debt management, inventory management, and revenue collection.

Because net working capital subtracts out all current liabilities, it is a much more thorough and comprehensive view of a company’s financial health than gross working capital.

Working Capital Line of Credit

While it’s always ideal to have enough capital available to finance day-to-day operations, most businesses eventually will face a cash shortage as a result of unforeseen circumstances. In these cases, a working capital line of credit is a good solution. A working capital line of credit is a commitment from a lender or other financial institution to provide cash when needed. In a LOC account, the business may withdraw funds as often as necessary to cover its expenses, payroll and other costs, assuming the maximum committed LOC amount set forth in the Line of Credit Agreement is not exceeded.

A business line of credit differs from a business loan in an important way: interest is not usually charged on the unused funds of a line of credit. Since a business withdraws funds only as needed, interest is only accrued on the funds that are withdrawn.

When cash becomes available to the business, the LOC lender expects the business to pay down the balance owed.

Additionally, the payment terms for a commercial line of credit typically are more lenient than a term loan because normally interest accrued on the LOC is the amount required to be paid. Whereas most term loans require both interest and principle to be paid each month making the payment much larger than an LOC interest-only payment.

Because financial institutions are much more likely to approve your business for a line of credit when you are financially secure, it is generally recommended that you have a business line of credit as a part of your overall financial plan, even if you don’t need one! Doing so will allow the business to access the cash needed when times get tough and maintain normal day-to-day operations.

Working Capital Target

As a business, it is important to have a working capital target, or the amount of working capital you ideally strive to have on hand on an ongoing basis.

A working capital target should be set where it’s possible to maintain sufficient cash to pay for day-to-day expenses and to have some extra to cover unforeseen expenses. Sitting on excessive cash is not ideal and should be redirected or invested for the future growth of the company.

And if your business is for sale and it is sold under an Stock Purchase Agreement, the buyer will usually identify the working capital target it expects the business to have at the time of closing. Buyers may also include in the terms of the stock acquisition agreement a clause which requires an adjustment to the cash to be transferred from the buyer to the seller at the closing should the working capital target fall short.

Growth Capital vs Working Capital Summary

Business owners who understand the various forms of business capital available and when growth capital vs working capital is most appropriate to meet the day-to-day changes in cash availability are better prepared to succeed in the long term.

It’s not unusual for businesses which are fast-growing to run into issues with cash flow and find it difficult to obtain capital. The availability of working capital Lines of Credit from banks depends mostly on how the business has performed in the previous year or two. This means keeping up with the cash requirements to fund payroll and to pay vendors when a business is in a hyper-growth situation can be very difficult.

In such circumstances, growth capital may be necessary — whether it’s from an equity investor or in the form of a term loan from a traditional lender. And in certain cases, considering other alternative forms of capital may be appropriate.

Ideally, understanding the reasons for the cash flow shortages and anticipating what’s going to be happening in the next few years in terms of business growth is wise. Doing so will allow the business owner to have the right type of business capital available to sustain and grow his business.

Capital Sources For Your Business

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Whether you’re growing a business organically or searching for ways to jump start business growth with a large cash infusion, don’t allow the large number of capital sources for your business become overwhelming.

This post identifies several non-traditional (i.e. non-bank) sources of capital for your business.

Outside Investors

Debt and Equity Mezzanine Bridge Capital
Bridge Capital is used by high growth middle market businesses in need of $5 Million or more for a period of three-to-seven years and who are capable of paying 20% plus for the use of the Investors capital.  Debt Mezzanine is often used in conjunction with a bank debt facility and is considered quasi-equity.    Accounts Receivable and Inventory may be used as collateral with Debt Mezzanine.  Equity Mezzanine is best suited when there is a very large potential upside in the business valuation in the future.  Whether using Debt or Equity Mezzanine for capital, it’s safe to assume the business is expected to grow significantly, become more profitable, and be sold to a third party in three-to-five years. When a business crosses the line and takes on Mezzanine Debt or Equity, it is considered a business that is ‘in play’.

Private Equity Group
Private Equity Groups invest capital in the form of equity into private businesses and typically buyout part or the majority of the original founders/shareholders.   This recapitalization offers the business owner an opportunity to sell twice:  once to the PEG; and then again when the PEG sells to another investor and/or buyer.  PEG’s invest in a business because they believe in its management team while recognizing the need for both capital and strategic management to take the business to the next level.

Venture Capital
Venture Capital firms invest capital in the form of equity into private businesses based on their belief in the business model and the   management team’s ability to scale-up with capital, connections, and advice.  Board participation on the part of the VC firm nearly always is mandated, and often controlled by the venture capital firm.

Angel Investors
Angel Investors invest capital in the form of equity into private businesses based on their relationship and confidence in its founder.  Angels invest capital in the early stage and their participation in the business management varies widely.

Alternative Capital

Accessing alternative capital sources outside of banks, credit unions, friends and family comes with an increase in the overall cost of capital.  In other words, as the business owner travels up the business capital food chain, access to capital becomes more expensive in terms of the net interest rate or cost of business capital paid on an annual basis.  Below is a summary of the cost of business capital  by the following categories:

Debt – Banks, Credit Unions, Friends and Family | Alternative Capital; and

Equity – Mezzanine, Private Equity Groups, Venture Capital, and Angel Investors:

capital sources business

Alternative Forms of Business Capital include:

Financing Companies
These provide Capital and Operating Leases to business, similar to a term loan, however the underlying interest rate (cost of capital) is greater.

Peer-to-Peer Crowdsourced Lenders
Following the lead from the U.K., these lenders are now emerging in the United States.  They pool private investors cash and lend to entrepreneurs in a streamlined application process.

Accounts Receivable Factoring
This lender acquires or buys some or all of the Accounts Receivable of a business and subsequently collects the payments directly from customers.

Purchase Order Financing
This lender is similar to an A/R Factoring Lender, however instead of purchasing the Account Receivable related to a customer, the lender acquires the Purchase Order from the customer.  The P.O. Financier advances the capital needed to fulfill a purchase order, and once paid by the customer, it pays the business owner who produced the product at a reduced factor.

Inventory Financing
This lender typically lends money to the business owner for high-priced merchandise that takes a long time to sell.  Automobiles, boats, and jewelry businesses use this form of financing.  When the business sells the product, it pays the Inventory Financier.

Merchant Cash Advances
A sum of money is advanced to a business that collects sales revenue through credit and debit cards from its customers.  Such a business is called a merchant and, at the end of each day, a portion of the daily receipts is remitted to pay down the sum of money initially received.  Retailers and restaurants frequently use this form of alternative capital.

Friends and Family

Raising business capital from friends and family is the most common path and largest source of funds for startups.  Business capital from friends and family is based on their comfort and confidence in the entrepreneur.  Typically friends and family do not have the financial or business savvy to  evaluate capital needs properly or judge the financial soundness of a business.  For this reason, many refer to this source of business capital as ‘Friends, Family and Fools’ capital.

The friends and family business capital source may be the only option for the startup. If so, the entrepreneur is well advised to accept a loan or investment only from friends and family members who can afford to lose their capital.  And careful consideration should be given to how the relationship may change if the loan or investment is not repaid or successful.  Proper structuring of the loan or investment is important when using the friends and family to start or grow a business.

Loan Covenants Examples

Loan Covenants Examples

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What Are Loan Covenants?

A covenant is simply a fancy term for the word ‘promise’. Banks include covenants in their loan agreements to preserve their position as the lender and to improve the likelihood a loan will be paid back by the business owner/borrower on time, in full, and in accordance with the loan’s terms and conditions.Loan Covenants Examples

Loan Covenants spell out exactly what the business owner agrees to do with respect to the business’ capital structure during the term of the loan or business line of credit.  These promises made by business owners can vary and most loan documents have some, but not necessarily all of the loan covenant examples defined in this post.

Knowing what to expect when you apply for bank financing and ultimately sign a lender’s loan document will help a business owner be well-prepared before and during the term of the loan.

Types of Loan Covenants

Bank loan agreements may include three types of loan covenants.  These include: Affirmative Loan Covenants, Negative Loan Covenants, and Financial Loan Covenants.

Affirmative Loan Covenants

An affirmative loan covenant is used to remind the borrower they should be doing certain activities to maintain the financial health and well-being of the business.  

Affirmative Loan Covenants Examples Include: 

  1.       Requirement to pay all business and employment-related taxes
  2.       Requirement to maintain current financial records and to deliver to the lender for review certain types of reports such as a Certified Public Accountant’s  Compiled, Reviewed or Audited financial statement   each year. 
  3.       Requirement to maintain adequate insurance policies for the business and possibly include the lender as a separately named ‘additional insured’ party 
  4.       Requirement to maintain the business entity in good standing with the state where it is formed

Negative Loan Covenants

A negative loan covenant is used to create boundaries for the company and its owners.  Such boundaries are usually related to financial and ownership matters.  

Lenders may include negative loan covenants which require the business owner to seek the bank’s permission to take certain actions as such actions may change the business’ capital structure.  Such requirements to obtain the lender’s permission may seem as if the business owner must ask “Mother, may I?…” and often are not evident to the business owner until many months, or even years, after the loan has been obtained.

 Negative Loan Covenants Examples Include: 

  1.      Limiting the total amount of indebtedness for the business and/or shareholders
  2.      Restriction on or forbidding distributions and/or dividends paid to shareholders
  3.      Restriction on or forbidding management fees paid to related parties
  4.      Prevention of a merger or acquisition without the lender’s permission
  5.      Prevention of investment in capital equipment, real estate, or other businesses without the lender’s permission
  6.      Prevention of the sale of assets without the lender’s permission
  7.      Maintenance of  a specific or targeted Debt Service Coverage Ratio

Financial Covenants in Loan Agreements

Financial loan covenants are used to measure how closely the business performs against the financial projections provided by the business owner, CFO, or management.  Certain financial loan covenants may be used to restrict the amount of credit the business can access from its line of credit.

Financial Covenants Examples Include:

  1.        Current Ratio (Current Assets divided by Current Liabilities
  2.        Borrowing Base Calculation where a defined maximum percentage is applied against the business’ eligible Accounts Receivable to determine how high a Line of Credit may be drawn.

Breach of Loan Covenants

In the event the business owner violates one or more of the loan covenants, the lender may dole out a number of consequences as it sees fit.  Depending on the offense, your lender may simply voluntarily create a waiver to accommodate the issue.  For example, if you forget to submit your financial statements on time, they may simply extend the deadline.  

However, in the event of a more serious violation (like taking out another loan without your lender’s permission), your lender may have the right to suspend its loan, demand early repayment, seize the assets you pledged as collateral, halt any additional lending to you, or initiate legal action.

And in most cases, lenders will charge additional fees to cover their additional costs when a loan covenant has been broken by the borrower.   These fees can be very costly.  These breach of contract fees are defined in the loan or line of credit agreement in the fine print.

Business owners should note that even an unintentional violation of a loan covenant may become a serious matter.  Some banks automatically turn their business accounts in violation of a bank covenant over to the Workout or Special Assets Group  for resolution.  Should this happen, a business owner may be forced to find an alternative source of business capital to grow their business.

find a business advisor exit promise

Are Bank Loan Covenants Negotiable?

Absolutely yes! Loan covenants are negotiable between the bank and the business owner when the bank or lender offers a borrower a loan and defines its proposed terms in the form of a Letter of Interest.  

Although a lender’s Letter of Interest or credit facility proposal is not binding on the part of the lender, it does serve as a good place for a business owner to begin to understand how the lender intends to impose loan covenants on the business owner.  It’s always best to understand loan covenants before agreeing to accept a lender’s business loan.

Business Debt Schedule

Business Debt Schedule

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Business Debt ScheduleA business debt schedule is a tool that helps businesses review, assess, and visualize debts. A debt schedule allows businesses to make strategic decisions about paying off debt, acquiring new debt, or creating long-term projections for investors and creditors.  It also helps a business owner understand the monthly debt service requirements for his or her business.

Elements of A Business Debt Schedule

Your business debt schedule should include a list of all your business-related debt, including any loans, leases, contracts, notes payable, and any other miscellaneous payables. Keep in mind that regular short term expenses – like accounts payable and accrued liabilities are not generally included in a debt schedule.  Accounts payable also does not normally include payroll, real estate taxes, and other types of taxes. Instead these are recorded on the company’s balance sheet as the expense is accrued.  

Details of each debt should be included in the debt schedule. These details include the creditor or lender, the current balance and the original total debt amount, the interest rate, monthly payment, maturity date, due date, and any collateral pledged.

There are a number of websites that offer a business debt schedule template to help you get started.

Business Debt Schedule Uses

A business debt schedule offers a complete view of your business’ debts, making it an important tool that can be used in a variety of ways depending on your needs. The schedule may help you make on-time payments, maintain accurate bookkeeping and forecasting, decide whether you can take on more debt, provide key information to a new lender, and help you monitor your business’s overall financial health.  

Not only is a debt schedule useful for you and your business, but lenders, creditors, and potential buyers will also use it to evaluate your company’s risk/reward profile.

Keep It Updated

A debt schedule for your business is only as useful as it is current. An updated business debt schedule could help you negotiate better interest rates, or show potential investors that your company is worthy of receiving new investments.

Maintaining an updated business debt schedule will also help you decide which debts should be paid off first, or help you make a convincing case to a lender in the event you decide to renegotiate interest rates by refinancing.

Alternatively, the debt schedule for your business is useful when considering a debt consolidation loan.

Business Debt Consolidation

Business Debt Consolidation

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Business Debt ConsolidationBusiness debt consolidation refers to the practice of taking out a new loan to pay off any number of other business debts (generally unsecured debts). Multiple separate debts are combined into one new loan, often with more favorable loan terms and conditions.  Such terms and conditions may include a lower interest rate, a longer payback period or balloon payment, and/or a lower monthly payment.

For small and medium sized business owners, it may be particularly easy to find that your business has taken on more loans than you’re comfortable having.  Emergencies and unexpected dips in cash flow may leave you in a debt cycle that you would like to escape.

Keeping up with multiple loan payment due dates and amounts can become burdensome,   even overwhelming.  When that’s the case, debt consolidation can be a useful tool to improve cash flow, reduce the number of payments from many to one, reduce the cost of business capital , and ultimately simplifying the process of managing your business.

Business Debt Consolidation Loan

While using any single form of financing to pay off multiple other debts technically is   considered debt consolidation, some financial institutions offer specific debt consolidation loans. These loans are financial instruments designed for borrowers who are looking to reduce several debts into a single loan (or who are looking for the benefits associated with a lower interest rate or lower monthly payments).

There are two types of debt consolidation loans: secured and unsecured. Secured loans are backed by collateral, while unsecured loans are not. As such, unsecured loans are more difficult to obtain, often at offer higher interest rates, and require lower qualifying amounts.

Refinance Business Debt

While business debt consolidation and business debt refinancing can be similar, they have some slight differences. When refinancing a loan, you pay off a single original loan using a new loan with more favorable terms. For many small business owners with numerous high-interest rate small-business loans and cash advances, simply refinancing may not be an option. Instead, these business owners may turn to debt consolidation to secure better interest rates and other more favorable borrowing terms and conditions.

MVIC (Market Value of Invested Capital)

MVIC (Market Value of Invested Capital)

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MVIC

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What is Invested Capital?

MVIC (Market Value of Invested Capital) is the amount of money raised by issuing securities to shareholders and bondholders, and typically includes total debt and any capital lease obligations.

The Market Value of Invested Capital Equation

The Market Value of Invested Capital (or MVIC) is equal to the market value of the owners’ equity plus any long-term interest bearing debt. Similar to Enterprise Value, Market Value of Invested Capital is a measure of total firm value, representing the value of all core operations of a business.

What MVIC Means for Small Businesses

MVIC is used widely to measure the value of small businesses, representing the total capital invested in the company, including any tangible assets and goodwill.

In the context of selling a small business, MVIC generally does not include any consulting agreement values, the value of any business-owned real estate, or any contingent portion of the purchase price (such as an earnout payment). It does, however, include the value of any non-compete agreements with the outgoing management team, and may include the value of any current assets that are transferred to the buyer.

Why MVIC Is the Preferred Method for Assessing a Small Business

First, most small business sales are structured as asset transactions, in which the buyer pays MVIC for the business, receiving all assets as a part of the transaction (and potentially assuming some liabilities as well).

Second, small business owners often have a controlling ownership interest in the company. This means that the owner is capable of changing the business’s capital structure by simply changing the balance between equity and debt capital.

The Difference Between Market Value of Invested Capital and Enterprise Value (EV)

While both EV and MVIC are measures of total business value, both are considered to be ‘capital structure neutral’, and both facilitate a relative value analysis. Yet there are significant differences between the two.

Put simply, MVIC includes cash assets, while EV excludes such assets. However, the inclusion or exclusion of cash can vary widely, so it is important to investigate the most appropriate way to calculate your business’s Market Value of Invested Capital.

As an example, some businesses may include all cash in MVIC, while others may include only an operating level of cash. Conversely, some professionals may exclude all cash from EV calculations, while others may exclude only excess cash.

When comparing your firm’s value to others, it doesn’t matter if you choose to use an MVIC or EV valuation. What is important is that you make apples to apples comparisons. Make sure you use the same valuation method for comparison, and be sure that cash assets are included or excluded in the calculation the same way across companies.

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Determine the Best Type of Business Loan for your Business

Determine the Best Type of Business Loan for your Business

by | Business Capital | No Q&A Yet

Best Type of Business Loan for your BusinessOnce you’ve successfully assessed your financial needs for a business loan, you’ll want to follow these guidelines to determine what, if any capital funding you may need, and the best type of business loan for your business.

What are the best reasons for a small business to pursue funding?

How can you best determine if you need more capital to fund your business?

Capital funding is needed for one of several reasons which include:

  1.  To meet short-term cash flow needs.  An example of this situation is when your business has employees which are paid every two weeks while your customers/clients pay you within 30 days of invoice (if you are lucky!).  This is a short-term capital need and is best managed with a Line of Credit.  Another source for short-term cash flow needs is an Alternative Lending company. Such companies lend against Accounts Receivable and in certain cases, Inventory.
  2.  To purchase a building, equipment, large tools, and other physical property that lasts more than a few years.  These are mid-term to long-term capital needs and are best managed with a term loan.
  3.  To acquire inventory or to purchase a business.  This type of loan is offered by lenders based on the ability of the business to make a profit and pay the bank back in approximately seven years.  Often this type of loan involves SBA Lending from the federal government.
  4.  To start a new business or expand an existing business into a new market.  This type of funding is sourced typically from the business owner’s personal funds, friends and family, banks, Venture Capital (VC) funds, Private Equity (PE) funds, angel investors, and crowdfunding.

Whether you need additional business capital depends on the type of business capital you are pursuing.

Capital To Meet Short-Term Cash Flow

If you are collecting your Accounts Receivable within the terms you’ve established with your customers and are having difficulty paying your vendors, employees, payroll taxes and other parties on time, you either have a business that is not making a sufficient profit, or one that  is growing at a rate that has outpaced your existing capital structure.  

If you’re business is not profitable, borrowing money will only serve as a temporary solution, unless you find a way to make a profit.  And if you borrow too much before your business turns the corner, the additional debt may prove fatal.  Business profitability will be necessary for the business’s long-term viability.

On the other hand, if your business is growing and profitable, it may be time to increase your line of credit.  A good rule of thumb is to divide your gross revenue for the last twelve months by ten.  That’s the amount of money your business should have access to via a line of credit.

Capital for Large Purchases or Inventory, Buying, Starting or Expanding a Business

These types of capital needs must stand on their own merits to warrant raising either borrowed money or equity (capital).  In each of these situations, it will be necessary for the business owner to establish his case that the investment will have a positive return.

How to Assess Your Need for a Business Loan

How to Assess Your Need for a Business Loan

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Need for a Business LoanAs a small business, it is imperative that you understand your financial needs. Knowing your projected annual expenses, having a business plan in place, and assessing your need for funding sets the foundation for a profitable and successful business venture. To better assess your need for a business loan, you’ll need to take a good look at a number of factors.

What documentation do you need to assess your financial needs?

(Business plan with financial projections, P&L statements, balance sheet, sales forecasts, cash flow statement)

All of the above!  First, you must have a business plan that defines when you will be putting revenue in the bank.  And it must be based on something concrete.  No wishful thinking.  Make certain you do the research to learn about your industry and what it takes to monetize.  This is the number one problem I see with startups.  Often they believe with a good idea one can start a business, and in some magical way, money shows up.  Monetizing any new business is very difficult.

Once that research is done, it’s important to build out your projected annual expenses, a three-year projected Profit and Loss Statement, and Balance Sheet.  You may need help to do this.  Hire that help only after you’ve done your research or you will be wasting your money.  Most accountants won’t do the research; they just build the numbers based on what you provide.  

The Accountant, CPA, or other business financial advisor should be able to help you determine how much capital you need to raise and how long it will last, once the three-year projections are prepared.

Resources to get started creating the necessary documentation

You can always find software online to handle these types of projections and statements.  That said, Excel is free and it works well when you are building out your revenue and expenses.  That’s the meat of your research.  Just google it and you will find free Excel templates.  

What is your ability to repay the loan?

Traditional bank loan agreements typically identify the debt service coverage ratio (DSCR) your business will have to meet to remain in good standing.  It’s defined as a ratio of income to debt service (principal and interest) and is normally set forth in the range of 1.20-to-1.25 by most lending institutions.  

We offer a free tool to calculate your business’ DSCR  on our website. It helps business owners understand what they should expect.  It’s a very popular tool because it tells you exactly where to find your figures to compute your business’ DSCR.

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