PERSONAL LOANS, BANK LOANS, AND SBA LOANS
by Jennifer A. Grady, Esq. and Tristan Younghaus, Esq.
Starting a business can be an exciting, yet costly endeavor. Entrepreneurs need startup capital to cover the cost of living expenses, salaries, overhead, legal fees, filing fees, marketing/advertising, shipping costs, and even production costs. There are numerous funding options available, from interest free loans to venture capital. In this two part series, we will explore the various options that are available for small business owners and entrepreneurs. In this blog, we will discuss loans/gifts from family and friends, bank loans, and Small Business Administration loans. The next posting will explore government grants, venture capital, and crowdfunding.
1. Loans/Gifts From Family and Friends
One of the most common places entrepreneurs begin when searching for funding is by soliciting loans from family and friends. These personal loans are not considered to be a “loan” by the Internal Revenue Service unless the terms of the agreement are stated in writing, (i.e. by stating the loan amount and the interest rate to be paid). Otherwise, after January 1, 2013, the IRS considers the money given to be a gift, and subject to the Federal Gift Tax, if the loan amount is over $14,000.
For borrowers, it may be most advantageous to have the terms of the loan written loosely, and to set proper expectations for all parties involved. For example, in order to preserve the integrity of the personal relationship, the borrower should make it clear that the loan should actually be considered a “gift” in the lender’s mind, and that the lender maintain the expectation that it may never be paid back. This is due to the high likelihood that the money will not be recouped. The borrower may want to avoid memorializing a specific date of repayment, with terms such as, “borrower to pay back loan when monthly income is greater than $10,000.00,” or whenever a reasonable amount is reached.
On the other hand, the friend or family member making the loan may want to outline more concrete payback terms, such as the exact dates of repayment and interest rates. Regardless, both sides should be clear on the terms of the agreement before giving or accepting funds.
Another option for the lender who wants more security, and even a tax write-off, is to involve the bank with the loan. For example, the borrower could apply for a loan with the bank, and the lender would use collateral to attach a Certificate of Deposit to the loan. The bank would then borrow the money, but if the bank is unable to satisfy the loan from the borrower or business’s assets, the bank would use the CD to satisfy the loan. An additional benefit of this option is that the friend or family member is gaining interest for their money in the CD and will offset future income taxes if there are any losses.
2. Bank Loans
Small business loans from banks are an option if the borrower has good credit; however, many banks have requirements that a business be in existence for a certain amount of time before applying for a loan, which varies depending on the industry. For example, CitiBank requires that the borrower has been in business for a year prior to applying for certain industries. Bank of America requires that the borrower has been in business five years prior to applying for a loan for certain industries.
Additionally, banks may necessitate that the borrower has collateral, and in the case that they are not able to pay back the loan, it will take the property. It is important to make sure the collateral offered is something that the borrower can live without if he or she cannot pay back the loan. Finally, make sure that the bank loan that is offered is for a favorable interest rate and that the bank is not taking advantage of the borrower. Always read the terms of the loan carefully, especially if a personal guarantee is required.
3. Small Business Administration Loans
U.S. Small Business Administration, which was established in 1953 by the U.S. Government and located online at www.sba.gov, makes direct business loans and guarantees bank loans to small businesses with government funding. The SBA has many different types of loans and programs based upon the type of business, which have additional requirements as determined by the SBA to qualify. Some of the loan types include the following:
- The 7(a) Loan Program, SBA’s most common loan program, includes financial help for businesses with special requirements.
- SBA’s Microloan Program provides small, short-term loans to small business concerns and certain types of not-for-profit child-care centers.
- The CDC/504 Loan Program provides financing for major fixed assets such as equipment or real estate.
- SBA provides low-interest disaster loans to homeowners, renters, businesses of all sizes, and most private nonprofit organizations. SBA disaster loans can be used to repair or replace the following items damaged or destroyed in a declared disaster: real estate, personal property, machinery and equipment, and inventory and business assets.
The SBA can help facilitate a loan with a third party lender, guarantee a bond, or help business owners find venture capital. For more information, visit http://www.sba.gov/content/sba-loans.
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The Grady Firm attorneys specialize in business advising for small business and Startup owners, and can help draft and revise contracts. To schedule a complimentary consultation, call (323) 450-9010, or fill out a Contact Request Form.