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BLOG: Financing your Business Part II – Credit Factors
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iStock_000003732935SmallThe first part of this series, An Overview of Business Financing, gave you important questions to help you determine your need for financial assistance.  We also briefly touched on some of the programs the SBA provides to assist business owners that are seeking financing.  However, before you can qualify for SBA’s financial assistance, you should first understand some basic credit factors that apply to all loan requests.

Every application needs positive credit merits to be approved. These are the same credit factors a lender will review and analyze before deciding whether to internally approve your loan application, seek a guaranty from SBA to support their loan to you, or decline your application all together.

Equity Investment

Business loan applicants must have a reasonable amount already invested in their business. This ensures that the business can operate on a sound basis when combined with borrowed funds and that the applicant will be sharing the risk with the lender. There will be a careful examination of the debt-to-worth ratio of the applicant to understand how much money the lender is being asked to lend (the debt) in relation to how much the owner(s) have invested (the worth). Owners invest either assets that are applicable to the operation of the business and/or cash which can be used to acquire such assets. The monetary value of invested assets should be substantiated by invoices or appraisals for start-up businesses, or current financial statements for existing businesses.

Strong equity with a manageable debt level provides financial resiliency to help a firm weather periods of operational adversity. Minimal or non-existent equity makes a business susceptible to miscalculation and thereby increases the risk of default on — failing to repay — borrowed funds. Strong equity ensures that the owner remains committed to the business. Sufficient equity is particularly important for new businesses. Weak equity makes a lender more hesitant to provide any financial assistance. However, low (not non-existent) equity in relation to existing and projected debt — the loan — can be overcome with a strong showing in all the other credit factors.

Determining whether a company’s level of debt is appropriate in relation to its equity requires analysis of the company’s expected earnings and the viability and variability of these earnings. The stronger the support for projected profits, the greater the likelihood the loan will be approved. Applications with high debt, low equity, and unsupported projections are prime candidates for loan denial.

Cash Management

Companies fail when they run out of money.  Understanding cash management is critical.

Financial obligations are paid with cash, not profits. When cash outflow is larger than cash inflow for an extended period of time, a business will run out of money and not be able to continue operating. As a result, cash management is extremely important. In order to adequately support a company’s operation, cash must be at the right place, at the right time and in the right amount.

A company must be able to meet all its debt payments, not just its loan payments, as they come due. Applicants are generally required to provide a report on when cash comes in (revenue) and when cash goes out (expenses)on a monthly basis, starting when the loan is expected to be received.  This report is a Cash-Flow Projection Report.  The numbers will not be the same every month, because sales and payments will not be exactly the same every month.  You should write down all assumptions which go into the estimations of both revenues and expenses and provide these assumptions as part of the report.

All applicants for loans must be able to reasonably demonstrate the “ability to repay.” For an existing business wanting to buy a building where the mortgage payment will not exceed historical rent, for example, the process is relatively easy.  In this case, the funds used to pay the rent can now be used to pay the mortgage. However, for a new or expanding business with anticipated revenues and expenses exceeding past performance, the necessity for the lender to understand all the assumptions on how these revenues will be generated is paramount to loan approval.

Working Capital

Working capital is defined as the excess of current assets over current liabilities.

Current assets are the most liquid and most easily convertible to cash, of all assets. Current liabilities are obligations due within one year. Therefore, working capital measures what is available to pay a company’s current debts. It also represents the cushion or margin of protection a company can give their short term creditors.

Working capital is essential for a company to meet its continuous operational needs. Its adequacy influences the firm’s ability to meet its trade and short-term debt obligations, as well as to remain financially viable.

Collateral

To the extent that worthwhile assets are available, adequate collateral is required as security on all SBA-guaranteed loans. However, SBA will generally not decline to guarantee a loan where inadequacy of collateral is the only unfavorable factor.

Collateral can consist of assets which are usable in the business and personal assets. Borrowers can assume that all assets acquired with the borrowed funds will be used as collateral for the loan. Depending upon how much equity was contributed towards the acquisition of these assets, the lender also is likely to require other business assets as collateral.

For all SBA-guaranteed loans, personal guarantees are required of every 20% or greater owner, plus others individuals who hold key management positions. How much in personal guarantees will be required is based on the value of the assets already pledged compared to the amount borrowed. In the event real estate is to be used as collateral, borrowers should be aware that banks and other regulated lenders are now required by law to obtain third-party valuation on real estate related transactions of $50,000 or more.

Certified appraisals are required for loans of $100,000 or more. SBA may require professional appraisals of both business and personal assets, plus any necessary survey, and/or feasibility study.

Owner-occupied residences generally become collateral when:

  • The lender requires the residence as collateral
  • The equity in the residence is substantial and other credit factors are weak
  • Such collateral is necessary to assure that the principal(s) remain committed to the success of the venture for which the loan is being made
  • The applicant operates the business out of the residence or other buildings located on the same parcel of land

Resource Management

The ability of individuals to manage the resources of their business, sometimes referred to as “character,” is a prime consideration when determining whether or not a loan will be made. Managerial capacity is an important factor involving education, experience, and motivation. A proven positive ability to manage resources is also a large consideration.

Mathematical calculations on the historical and projected financial statements are used to form ratios that show how resources have been managed in the past. It is important to understand that no single ratio provides all this insight, but the use of several ratios in conjunction with one another can provides an overall picture of management performance. Some key ratios all lenders review include debt to worth, working capital, the rate at which income is received after it is earned (how quickly your clients and customers pay you), the rate at which debt is paid after becoming due, and the rate at which the service or product moves from the business to the customer.

During this series we will provide you with some examples of financial statements, as well as what bankers look for before approving a business loan.

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BLOG: Registering as a Government Contractor
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In our “Choosing your Entrepreneurial Path” series we discussed Government Contracting as one of the options.  Since this is a Virginia SBDC blog and the government literally lives in our backyard, it is likely that many of the entrepreneurs who are reading this are considering or already are building a government contracting business.

With that said, in this and future post we are going to dive much deeper into government contracting and the federal contracting process.  To start us off we are going to look at the importance of small business classification and the registration process.

What is a Small Business?

Federal, state, and local governments offer businesses the opportunity to sell billions of dollars worth of products and services to them. Many government agencies require that some percentage of their procurements be set aside for small businesses. To be a small business, you must adhere to industry size standards established by the U.S. Small Business Administration.

The SBA, for most industries, defines a "small business" either in terms of the average number of employees over the past 12 months, or average annual receipts over the past three years. In addition, SBA defines a U.S. small business as:

  • Organized for profit'Having a place of business in the US
  • Operating primarily within the U.S. or making a significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor
  • Independently owned and operated
  • Not dominant in its field on a national basis

The business may be a sole proprietorship, partnership, corporation, or any other legal form. In determining what constitutes a small business, the definition will vary to reflect industry differences, such as size standards.

Size Standards

The most common size standards for “small business” are as follows:

  • 500 employees for most manufacturing and mining industries
  • 100 employees for all wholesale trade industries, except federal prime contractors and subcontractors where the maximum number of employees is 500
  • $6.5 million for most retail and service industries
  • $31 million for most general and heavy construction industries
  • $13 million for all special trade contractors
  • $0.75 million for most agricultural industries

About 25% of all industries have a size standard that is different from these levels. They vary from $0.75 million to $32.5 million, based on average annual revenues, and from 100 to 1,500 employees for size standards based on number of employees. Several SBA programs have either alternative or unique size standards, such as the Small Business Investment Company Program.

SBA has also established a table of size standards, matched to North American Industry Classification System (NAICS) industries. The table is available at http://www.sba.gov/size.

In addition to establishing eligibility for SBA programs, all federal agencies must use SBA's size standards for their federal government contracts to identify small businesses. Agencies must also use SBA’s size standards for their other programs and regulations, unless they are authorized by federal statute to use something else.

For further information, you may contact the Office of Size Standards:

Office of Size Standards
U.S. Small Business Administration
409 3rd St., SW, Washington, DC 20416
Phone: 202-205-6618 — Fax: 202-205-6390
Email: sizestandards@sba.gov

Once you have classified your company based on the established size standards, you are ready to begin registering to do business with the government. Follow these easy steps to certify your business as small and obtain the registrations you need to begin bidding on government proposals.

Steps to Registering as a Federal Contractor and to Certifying Your Business as Small

According to the SBA these are the steps you need to take when registering as a federal contractor:

  1. Obtain a D-U-N-S Number: You will need to obtain a Dun & Bradstreet D-U-N-S® Number. This is a unique nine-digit identification number for each physical location of your business. The assignment of a D-U-N-S Number is free for all businesses required to register with the federal government for contracts or grants. Visit the D-U-N-S Request Service to register or read a quick overview here.
  2. Register your Business with the System of Award Management (SAM):  You need to register your business with the federal government's SAM, the primary database of vendors doing business with the federal government. When you register, you will "self-certify" that your business as “small,” meaning you don’t have to supply documented proof, you just certify it by checking off that box. Federal Acquisitions Regulations (FAR) require all prospective vendors to be registered in SAM prior to the award of a contract, basic agreement, basic ordering agreement, or blanket purchase agreement.
  3. Find the NAICS Codes for Your Company:  You may also find that you need a North American Industry Classification System (NAICS) code for administrative, contracting, and tax purposes. The code classifies the economic sector, industry, and country of your business. For Federal contracting purposes, you will need to identify in SAM all the NAICS codes applicable to your business.  Read Identifying Industry Codes for more information.
  4. Obtain Past Performance Evaluations:  Businesses interested in getting on the U.S. General Services Administration (GSA) Schedule for contracts should obtain an Open Ratings, Inc. Past Performance Evaluation. Open Ratings, a Dun & Bradstreet Company, conducts an independent audit of customer references and calculates a rating based upon a statistical analysis of various performance data and survey responses. While some GSA Schedule solicitations contain the form to request an Open Ratings Past Performance Evaluation, vendors may also submit an online request directly to Open Ratings.

Items Needed for Registration

Below are some of the items that you will need in order to complete registration processes.

  • Your NAICS (North American Industry Classification) codes:  To find the NAICS codes, search at http://www.census.gov/eos/www/naics/. You can add or change NAICS codes at any time.
  • Your Data Universal Numbering System (D-U-N-S) Number:  As mentioned earlier this is a number given out for FREE by Dun & Bradstreet. You may get your number online at http://www.dnb.com
  • Your Federal Tax Identification Number (TIN), also known as an Employer Identification Number (EIN) or Form SS- 4:  This can be obtained online, by phone, or fax. For information, go to the IRS Small Business/Self Employed Community website at http://www.irs.gov/Individuals/International-Taxpayers/Taxpayer-Identification-Numbers-%28TIN%29/ and click on “Employer ID Numbers (EINs).”
  • Your Standard Industrial Classification (SIC) codes:  This is another type of code that describes your products and services. SIC codes can be four or eight numbers. You must have at least one SIC code for your registration to be complete. You can find your SIC code at http://www.osha.gov/pls/imis/sicsearch.html.
  • Your Product Service codes (PSC):  These are optional and provide additional information about your service for government buyers. Search for PSC codes at http://www.fpds-ng.com, click Downloads and scroll down to Reference Information.
  • Your Federal Supply Classification (FSC) codes:  These codes are optional and provide additional information about your products. Each Federal Supply Classification (FSC) code is derived from the Federal Supply Groups (FSG). Search for FSC codes at http://www.sider.com/fsc.htm.

More About Government Contracting

Contracting with the Federal government can open the door to many opportunities for your small business and can aid your business' growth. Visit the following pages for more information:

References

Small Business Development Website- www.sba.gov

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George Mason’s Mason Enterprise Center, as part of the Virginia SBDC and UANL are establishing the first International Sister Center partnership under the Small Business Network of the Americas
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Assistant Secretary of State for Western Hemisphere Affairs Roberta Jacobson and Ambassador of Mexico to the United States Eduardo Medina Mora will deliver remarks and witness the signing of a memorandum of understanding between George Mason University and the Autonomous University of Nuevo León (UANL), February 6, 2014 at 3:30 p.m. in the Delegates Lounge at the U.S. Department of State. As leading members of Small Business Development Center (SBDC) networks, George Mason’s Mason Enterprise Center and UANL are establishing the first International Sister Center partnership under the Small Business Network of the Americas (SBNA).

As Sister Centers, George Mason and UANL will cooperate on soft landing programs for small businesses looking to establish a presence in the vicinity of Monterrey, Mexico or the Commonwealth of Virginia. George Mason will be represented by the Vice President for Global and International Strategies, Dr. Anne Schiller; UANL will be represented by Vice President for Sustainable Development, Dr. Sergio Fernandez Delgadillo. The Sister Centers will also generally support activities that promote bilateral trade, share best practices in entrepreneurial assistance, carry out faculty and student exchanges, and explore other possibilities for collaboration between SBDCs hosted by each university.

Launched in 2012 at the Sixth Summit of the Americas, SBNA is President Obama’s signature initiative to promote entrepreneurship, innovation, and small business growth in the Western Hemisphere. For more information on SBNA, see www.youtube.com/watch?v=DSFDJMbx9FE. For inquiries on SBNA, please contact SBNA@state.gov.

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