Business Financing

A Rock and a Hard Place

  • A Rock and a Hard Place

There is a segment of the small business community that is often too small to secure needed financing through conventional means, yet not large enough to tap in to the network of investors available to larger companies. These small fish in big ponds are systematically hindered in their efforts to build and grow their businesses.

In the case of businesses too small to secure needed financing through conventional means, the barrier to entry is often the bank loan process. These loans are usually procured through the Small Business Administration, a program designed specifically to provide small businesses with access to capital. There are pros and cons to this program:


  • For less experienced businesses, SBA loan programs remain one of the best sources of capital.
  • Given the support of the SBA loan guarantee, SBA lenders are able to finance projects that lack collateral and are willing to finance soft costs, including franchise fees, leasehold improvements, working capital and goodwill for business acquisitions.
  • Borrowers are typically able to provide a lower up-front equity injection and obtain much longer loan terms and amortization schedules with SBA loans in comparison with conventional commercial loans.
  • SBA loans are structured with no balloon payments.  They feature longer terms and amortization schedules, which may be as long as ten years for a new lease location, and 25 year terms for real estate-based projects. This enables business operators to improve their cash flows.
  • In 2005, the SBA authorized an increase in the maximum loan guarantee from $1 million to $1.5 million, which qualified larger transactions for the SBA loan programs.


  • Extensive documentation required for SBA loans, because they are directly funded by lenders and backed by the U.S. government.
  • All SBA loans require the personal guarantees of owners with an interest of 20 percent or more in the business entity. Unlike non-SBA small business loans (such as Small Balance Loans), conventional lenders offer non-recourse or limited guarantees to businesses that are well capitalized and have a solid performance history. However, non-recourse financing is rarely available to smaller businesses.
  • The 504-loan program is limited to financing fixed assets such as real estate and equipment, and soft costs are not eligible.  Unlike the 7(a) program, soft costs such as goodwill, franchise fees and closing costs cannot be financed under the 504 loan. Since most franchise concept investments are below $2 million, the 7(a) program should be sufficient.
  • The SBA has established size-standard guidelines to define the maximum size at which specific business types would qualify for SBA loans. The size-standard guidelines vary between industries.  For example, most retail businesses with revenues greater than $6.5 million, most wholesalers with more than 100 employees and most manufactures with more than 500 employees would not be eligible for SBA financing. If one is a multi-unit operator, the SBA will base eligibility on an aggregate of all affiliated businesses and determine it based on a three year average. The SBA estimated that with these size standards, approximately 98 percent of all businesses in the U.S. are eligible for SBA financing.
  • The SBA has a $1.5 million maximum guarantee to any individual borrowers or related entity that controls more than 20 percent of a business interest with an outstanding SBA loan. The $1.5 million maximum guarantee is also aggregated on all outstanding SBA loans to that particular borrower or other business investments. For concepts with relatively low initial investments, borrowers may finance multiple units before exceeding the maximum guarantee.  However, for larger real estate-based concepts, the $1.5 million guarantee may limit the borrower to one SBA loan outstanding at any given time.

Although the SBA program is intended to facilitate small business growth, the fact that these loans are tied to a commercial bank severely restricts this financing option for small businesses. (We have the “Great Recession” to thank for this.) These restrictions make it difficult for small businesses to qualify for SBA loans. Apply for an SBA loan with a commercial bank, and it is the bank – not the SBA – that will require the business to provide collateral for every nickel they are borrowing.  Since the business has already plowed most of their profits into growing the business, the business will be hard-pressed to come up with that kind of collateral. The bank will also want extensive documentation regarding income, assets, expenses, income projections etc. to prove there is minimal risk to the bank in approving the loan.  It doesn’t help that the SBA guarantees the loan if the small business can’t meet the bank’s requirements in the first place.

In the case of businesses not large enough to tap in to the network of investors available to larger companies, the barrier to entry is access to investor networks. These networks of investors will often finance business deals with little collateral, other than that the business they are financing can show that their cash flow is sufficient to cover the debt service. Often all that is required for documentation is little more than a prospectus. In many cases, there is a personal relationship between the business owner and the investor network liaison; collateral is less a case of accounting documentation and more a case of “I trust this guy, he’s a friend of mine, we won’t lose money on this investment.”

The investor network primarily consists of “family offices”. These are private wealth management advisory firms serving the “1%” – ultra high net worth investors. Unlike traditional wealth management operations, family offices offer a total outsourced service covering all aspects of managing the financial and investment needs of the affluent. They are serviced by a team of experts from the business, estate, investment, legal, insurance and tax disciplines. Most family offices combine financial planning, risk management, cash management, asset management, and lifestyle management and related services. These services are essential for wealthy families to navigate effectively the wealth management issues it faces.

It comes as no surprise that family offices, and the wealthy families they service, are an insular group whose operations and strategies are kept close to the vest. This lack of transparency prevents access to their network and to the investment strategies they employ. Recent trends in family offices, however, have the potential to work in favor of the small business community.

  • Growth in Family Offices

As the number of ultra high net worth individuals increases, so too are the number of single- and multi-family offices. Studies forecast a 34% increase in this number over the next eight years. For both old and new members of the 1%, the family office model is an appealing structure since it provides increased oversight of employed professionals and the money they control.

  • Embracing Multi-Asset Strategies

Traditionally, family offices tend to avoid alternative investments which are highly illiquid and can take upwards of 10 years to realize returns.  This trend is changing, since alternative investment assets have the potential to enhance returns and provide an illiquidity premium, and offer the benefit of potentially diversifying risk exposures and cushioning market volatility. As an example, a recent survey conducted by eVestment reported that 60% of family office respondents planned to increase allocations to hedge funds over the next two years. Family offices that are incorporating alternatives in their client portfolios will often outsource investment management to professionals with structured strategies and expertise within these fields.

  • Impact Investing

As wealthy baby boomer families pass their assets to millennial heirs, these millennial heirs consider impact a critical investment factor. Many family offices are adopting this value-driven approach in anticipation of inter-generational wealth transfer. According to a recent Financial Times survey, family offices active in impact investing cited succession planning, alignment of family values, and contribution to a sustainable economy as top reasons for impact investing. The same survey reports that family offices allocated on average 17% of their assets under management to impact investments. Over the next decade, impact investing should not be regarded as simply a ‘nice-to-have’ niche.

Unless and until the current economic environment changes, small businesses seeking to grow through capital infusion will continue to be stuck between a rock and a hard place.