Quick Start Financing (4)

Collateral EvaluationStartups & Franchise Considerations

January 19, 2010

O r a n g e C o u n t y

SCORE®

Presentation By

John P. LafareManagement Counselor

SCORE – Orange County Chapter

How do I get a loan?

Loan Success!Experience

At least 3+ years

Good Credit700+, maybe less if quality deal, strong

credit history

Equity StakeUp to 40%

Business Plan Positive cash flows within 6

months

Collateral / Guarantees

IncomePast & Other Sources of

Income

Prepared by John Lafare

Alternatively, the five “C”s

Loan Success!ConditionsPurpose of the loan,

economic or competitive factors

CapacityHow will the

business repay the loan?

CapitalHow much the

owner(s) have at risk

CollateralSecurity or

guarantee that the loan will be repaid

CharacterJudgment about the persons involved in

running the business

Is collateral always required?

• Requirements vary by lender, type of loan

• Some programs do not require collateral

• Higher risk means more collateral

• Strong business plans and solid financial projections can reduce collateral needs

• Borrower needs to provide reasonable reassurance of repayment from earnings

• Collateral not a substitute for repayment ability

What are the lender’s collateral requirements?

• Often the last hurdle to clear

• If no collateral, may need a co-signer with collateral to pledge

• Any asset of value can be pledged

• Up to or above 100% of loan principal amount

• Actual percentage a function of:1. Risk on your loan2. Accumulation of institutional risk

What are the SBA requirements?

SBA expects every loan to be secured

Will not decline request if inadequate collateral is the only unfavorable factor

All available collateral must be offered

SBA may decline request if loan is not fully secured and collateral is available

Lenders may require more collateral, depending on equity contributed

What are the SBA personal guarantee expectations?

• For all SBA loans, personal guarantees are required for:– Every owner of 20% or more of the business– Other individuals in key management positions

• Whether a guarantee will be secured by personal assets is based on:– The value of the assets already pledged – The value of the assets personally owned relative

to the amount borrowed

When is an owner-occupied residence required as collateral?

The lender requires the residence as collateral

Equity in residence equals or exceeds 25% of fair market value, other credit factors are

weak

Collateral necessary to ensure principal(s) remain committed to the venture’s success

The business operates from the residence or other buildings located on the same parcel of

land

Which assets can be pledged?

Real Estate

• Real Property Owned (Buildings, Land)• Equity in the Home

Fixed Assets of the Business (Preferred)

• Buildings, Equipment

Current Assets of the Business

• Cash, Savings, CDs• Accounts Receivable, Inventory

Securities (IRA, 401K, 503b cannot be assigned)

• Stocks, Bonds

Other Assets, Both Tangible and Intangible

Factoring of receivables

• Can be used to convert credit sales for immediate cash flow

• Outright sale of receivables to a factor: – Receivables sold at a discount to book value– May charge interest on the balance until collected– Often withhold some money to establish a reserve

fund

• Value assigned to receivables:– Depends on the age of the receivables– Older than 90 days typically not financed

How are collateral assets valued?

Lenders and the SBA use their own respective valuation models

Value estimated or appraised, not based on market value

Discounted to account for loss of value should the assets have to be liquidated

Collateral valuation examples

Collateral Type Lender Valuation SBA Valuation

 House  75% of market value less

mortgage balance  80% of market value less

mortgage balance

 Car   Nothing  Nothing

 Truck/Heavy Equipment   50% of depreciated value    Same

 Office Equipment   Nothing   Nothing

 Furniture & Fixtures  50% of depreciated value   Same

 Inventory  40-50% of fair market value  Nothing

 Accounts Receivable  60-65% of eligible receivables 50% of eligible receivables

Interest Bearing Securities

 Amount no greater than cost  Same

 Stocks & Bonds  50%-90% of fair market value Same

 Mutual Funds  Nothing   Nothing 

 IRA Accounts  Nothing   Nothing 

 Certificates of Deposits  100%  100%

Who is lending?(Source: FY10 SBA Rankings Through 12/09)

SBA loans by top 10 lendersup 105% YOY

Challenges for start-up businesses

Never easy to win bank loans, even in the best of times

Some lenders look for a long track record of earnings, don’t lend to new firms at all

Don’t expect 100% funding

Where loans are available, banks my require up to a 40% cash investment

Franchises and collateral

• Systems listed in The Franchise Registry:– Eligible for expedited loan processing– Control provisions acceptable to SBA / lenders

• For those not on the list, collateralization may be limited by franchisor requirements

• Lenders also prefer franchisees who are buying rather than leasing a store and land

• Currently, banks may not only require more collateral but may also reduce valuations

http://www.franchiseregistry.com/