An SBA CAPLine might be the ticket
By J. Tol Broome Jr.
Working capital is the lifeblood of most small businesses, but it can be elusive. Business owners usually struggle to provide enough equity from their own funds, trade creditors have limits on terms, and banks are often reluctant to provide open-ended lines of credit based solely on the strength of the business and its assets. Yet working capital is absolutely critical to funding growth, as well as seasonal needs to ramp up assets that often 
arise during certain times of year for a typical mattress business.
The Small Business Administration historically was not a major player in providing guaranties for lines of credit. But a major policy revision in late 2011 changed all of that. In October of that year, the SBA instituted a new Working Capital CAPLine program, making it much easier for businesses to borrow against accounts receivable, inventory, contracts and purchase orders to fuel short-term seasonal needs and long-term growth. As a result, CAPLine volume more than tripled in fiscal 2012 to nearly $415 million nationally. And that number is expected to grow to $500 million-plus in fiscal 2013. Lenders in all 50 states now participate in the CAPLine program.
Karen Mills, director of the SBA from 2009 until August 2013, explained the rationale behind the CAPLine program changes after visiting a small business in Memphis, Tenn., in a 2011 blog post.
“As businesses like this grow and find new customers, we need to do everything we can to make sure they have the working capital they need to scale up and create jobs,” Mill wrote. “When a business lands a big order or wins a federal contract, they often don’t have the necessary cash on hand to hire workers and buy materials to fulfill it. Now more than ever we need to make sure a business in that position can secure the necessary financing to take full advantage of those opportunities.”
How does CAPLine work?
The SBA has four different CAPLine programs. The Contract, Seasonal and Builder CAPLine programs all address very specific needs in certain industries. Our focus here, however, is on the SBA Working Capital CAPLine program.
An SBA Working Capital CAPLine is a subprogram of the guaranteed loan platform found in section 7(a) of the SBA bylaws. In this case, a conventional bank—and any bank can participate in the SBA lending program—extends a line of credit to a mattress and bedding business with a 75% guaranty (85% for lines of $150,000 or less) from the SBA. This means that for a $1 million line, the most a bank could lose would be $250,000. But because the lines always are secured by the assets of the business and carry personal guaranties of the owner(s), the actual loss exposure typically is far lower. So a $1 million line of credit (or a line of credit of any amount) that might normally be declined by the bank becomes acceptable based on the combined strength of the SBA’s 75% credit enhancement, the assets of the business and the personal guaranty.
The maximum amount of a Working Capital CAPLine is $5 million; there is no minimum. The line can be used to fund cyclical growth, short-term working capital and the operating needs of the business—and even refinance other bank debt, in many cases. The line cannot be used to refinance SBA guaranteed debt or to finance the purchase or refinance of debt used for equipment, machinery, real estate or other fixed assets. The term of the line is negotiated between the borrower and the bank and can be for up to 10 years.
With a revolving structure, the line can be drawn up and down with proceeds used to buy inventory or to fund new accounts receivable, contracts or purchase orders. The line is then paid down as inventory is sold, accounts receivable and contracts are collected, and purchase orders are converted to sales.
The Working Capital CAPLine generally includes a Borrowing Base Certificate with a first lien against accounts receivable, inventory and other business assets and a limit of 1:1 coverage. In other words, the bank can lend up to 100% of the value of the assets of the business, which is far more favorable than most banks will lend for a conventional line of credit (typically, 70% to 85% on accounts receivable and 40% to 65% on inventory).
Servicing and reporting requirements mirror those generally included with a conventional monitored bank line of credit. The business must provide to the bank monthly agings of receivables and inventory, as well as quarterly financial statements. The bank must conduct an annual credit review and perform regular site visits and field examinations. These field exams always include an inspection of the books and records with an additional inspection of collateral if the line is $1 million or higher.
Advantages and disadvantages
What are the advantages and disadvantages of using the SBA Working Capital CAPLine program? As mentioned, the biggest advantage is increased access to funding for small businesses. Many CAPLines are done by banks that otherwise would decline the loan request. For some bedding business owners, a CAPLine might be the only available method to finance growth or seasonal borrowing needs.
A second advantage is the higher advance rates. Third, the revolving feature enables a business to pay down the line when cash flow is stronger (thereby avoiding unnecessary financing costs) and draw up the line when assets need to be built up and cash flow is tight. The alternative will sometimes be a term loan with the funds drawn out up front and repaid on a monthly basis over a specified time. In addition, a CAPLine offers an affordable alternative to more expensive working capital sources such as venture capital, credit cards and factoring.
The primary disadvantage of the CAPLine program is the higher cost compared to a conventional bank loan. Fees generally range from 2% to 3.5% of the guaranty amount. For example, a $500,000 CAPLine with a 75% guaranty of $375,000 and a 3% guaranty fee would result in a loan fee of $11,250, compared to less than 1% for most conventional bank loans. The interest rate is capped at prime + 2.75% (prime is currently 3.25%) for lines above $50,000. The spread above prime for a variable rate conventional loan is negotiable based on the risk perceived by the bank, but it is generally lower than 2.75%.
What businesses are eligible?
While the SBA estimates that more than 90% of businesses in America qualify as “small” under its qualifications, there are a few restrictions to borrow under the 7(a) program:
• The business must be for-profit.
• The business must be incorporated in the United States.
• Size restrictions vary by business type but generally are up to 500 employees or $21 million in annual revenue.
• The owner must have a “reasonable” amount of equity invested.
• The business must demonstrate the need for the loan proceeds.
• The use of the funds must be for a sound business purpose.
• The business must not be delinquent on any debt obligations to the U.S. government.
Your bank should be able to help determine if your business is eligible for a CAPLine line of credit. If your existing bank has no experience with the SBA, then it’s advisable to find one that has worked with the SBA. In fact, many banks are frequent participants in the SBA 7(a) program and attain Preferred Lender status with the agency, which results in a streamlined process for loan requests.
The bottom line
If you’re in the same boat as many business owners who have been unable to obtain a line of credit for your mattress and bedding venture, then your ship may have come in. The SBA Working Capital CAPLine program has provided much needed working capital financing for a growing number of small businesses in recent years, and it could do the same for you.
SBA Express lines of credit |
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The SBA Express program also allows businesses to borrow from banks with an SBA guaranty for lines of credit (and term loans) up to $350,000. Besides the maximum loan amount, there are several notable differences between the Express and CAPLine programs:
• The approval process for all SBA Express loans is streamlined for participating banks. When might the Express program make more sense than the CAPLine program? Banks often prefer the Express program due to the streamlined process. This means a quicker response for the bank and the business. Borrowers sometimes prefer the Express program because loans of less than $100,000 can be made with no collateral, and there is no asset monitoring requirement for any Express line. So, while the cost of financing generally is higher for Express than CAPLine, the Express program is more flexible with lower reporting requirements and is often preferred by both the bank and the borrower, particularly for lines of credit that are less than $100,000. |
