The U.S. government focuses on the growth of small business as a means to loosen the credit markets and create jobs. This strategy was substantiated by the signing of the Small Business Jobs Act of 2010, which was designed to create jobs by encouraging lending to small businesses, and to help kick off the recovery of the small business sector after the Great Recession. In order to take advantage of the new small business loan programs, tax breaks and other credit enhancements provided by the legislation, small business owners will need to obtain financing for new ventures and business expansion. The addition of debt capital and an increase in government support in the form of enhanced loan guarantees has prompted small business owners to establish and manage their business credit. (For more, see 6 Reasons To Be Excited About The Small Business Jobs Act.)
By focusing on the underwriting criteria that are included in their business credit files, small business owners can increase the probability of loan approval. Due to the importance of establishing and managing business credibility, various firms have been instituted to help small business owners manage their credit file. Well-managed business credit can help convince lenders that a firm is mitigating its business risks by demonstrating beneficial trade provisions with vendors and a superior payment history with its other creditors.
Tutorial: Starting A Small Business
Funding Small Business Expansion
In 2008, the federal government attempted to provide some market liquidity through the $825 billion stimulus package that, for the most part, targeted large banks and credit institutions. Although the added capital did help support major lending institutions, it did not result in encouraging new lending or creating new jobs in the amounts originally expected. In 2010, the small business sector of the U.S. economy employed just over half of all private sector employees, and was responsible for creating approximately 65% of all new jobs between 1995 and 2010, but the stimulus package had few provisions aimed at helping small businesses or that gave large banks and credit institutions a mandate to finance small business expansion. Small businesses, defined by the Small Business Administration (SBA) as commercial concerns with net assets less than $15 million or $5 million in average net income, have historically led the economy in job growth, but the inability to access debt capital was hampering growth in this sector.
In order to address America's high unemployment rate and create an anticipated 500,000 new jobs, the government provided additional debt capital and tax breaks for small business owners and investors through the Small Business Jobs Act of 2010. Signed into law by President Obama on September 17, 2010, the law could eventually leverage up to $300 billion in additional financing by funding $30 billion in seed capital, increasing loan limits, expanding government guarantees and offering borrowers better access to credit, all of which is intended to motivate small business investment and development. (For more, see Build Your Small Business During Downswings.)
There are several key provisions and approximately $12 billion in tax breaks included in the act to encourage loan origination and investment:
- The Small Business Lending Fund, a $30 billion credit facility, will provide capital to small banks earmarked for small-business lending.
- The State Small Business Credit Initiative will strengthen state small business programs by supporting at least $15 billion in small business lending.
- The law more than doubles the maximum loan size for the largest and most commonly used lending programs (7(a) & 504) guaranteed by the SBA
- SBA will fund new recovery loans and extend loan provisions to free up more than $730 million in loans from the Recovery Loan Queue to support an additional $14 billion in small business financing.
- 100% of the capital gains taxes are eliminated for investments in qualifying small businesses.
- The limits on Section 179 Expenses, which allow taxpayers to deduct 100% of certain types of property rather than requiring the property to be capitalized and depreciated, are doubled to $500,000.
- Small businesses can carry back general business tax credits to offset their tax burdens from the previous five years.
- Qualified start-up expenses have been doubled to $10,000 per year, and the total has been increased to $60,000.
- The Act extends 50% bonus depreciation under Section 168(k) by one year for qualified property placed in service during 2010.
- Taxpayers can recoup some previously unqualified healthcare costs.
- There is additional tax relief and simplification for certain expenses like cell phones, without the burdensome extra documentation formerly required.
- Limitations on Penalties for Errors in Tax Reporting That Disproportionately Affect Small Business are reduced and are calculated as a percentage, since the original fixed rate penalty was shown to be disproportionately large for small businesses.
According to President Obama, the "common-sense plan" will "help provide loans and cut taxes for millions of small-business owners without adding a dime to our nation's deficit." Although the terms of the new law offer incentive to encourage lending, supplying resources and motivating investors to use equity capital is not the end-all solution to the credit crisis.
To help persuade finance institutions to lend the available funds, the federal government is securing these small business loans by guaranteeing up to 90% of their principal value. In order to ensure that future loan defaults do not end up costing the government more than the economic benefit the law was intended to provide, lenders and the SBA will increase their focus on business credit lending guidelines in order to maintain defaults within program expectations. Although the underwriting process is specific to each lending institution. the first level of analysis is usually quite similar and will include some derivation of the following company and credit analysis before forwarding the credit file to the SBA for confirmation and approval.
- Financial Statement Analysis
A complete financial statement and cash flow analysis will be conducted so that the underwriter can determine sources of repayment. A business credit file allows owners to provide annotations and information not easily obtained from the financials.
- Coverage Ratios
As part of the financial statement and cash flow analysis, underwriters determine the loan-to-value (LTV), debt service coverage (DSC) and debt-to-worth ratios. This analysis provides a probability assessment on the likelihood that the loan will be repaid as expected.
- Trade History and Resource Management
The key to business credit, unlike personal credit that only tracks how one consumes, is that it provides trade credit and insight into the company's relationship with stakeholders like vendors and customers. It also provides insight into how efficient management is at employing resources.
- Managerial Proficiency and Character
Underwriters must be confident that management can achieve business plan objectives. Another benefit of establishing a business credit file is that, in conjunction with the financial statements, it can detail how the business has been managed over time.
Managing Business Credit
According to the SBA, insufficient or delayed financing is the second most common reason for business failure. The delay in obtaining funding can be significantly reduced when owners are proactive and establish business credit and some type of business credit score. Many small businesses fail because the owners have an incomplete knowledge of how to manage their credit profile appropriately and access the financing they need to cover their working capital and development expenses.
One rationale for establishing business credit and administrating the credit file is to assure that the market obtains an accurate representation of a company's ability to employ and manage debt financing. Considering that more than $30 billion in new capital is earmarked for federally guaranteed loans, it is imperative that small business owners establish and manage their credit file, the first step in obtaining SBA loan approval and accessing the committed funds.
Establishing business credit and maintaining a high credit score is not something that happens spontaneously; it is a step-by-step process that requires a strategy and a proactive approach. It starts by obtaining a DUNS number, Dun and Bradstreet's industry standard for keeping track of the world's businesses, and establishing a business credit file. By submitting financials to D&B on a regular basis, paying suppliers on time and resolving payment issues with vendors, owners demonstrate their creditworthiness and can help ensure a high PAYDEX score. The business equivalent of the FICO score, PAYDEX is a unique dollar-weighted numerical indicator of how a firm has paid its bills over the past year, based on trade experiences reported to D&B by various vendors.
Another reason to report transactions and manage business credit is that it is not protected like personal credit. Although the Fair Credit Reporting Act gives individuals the ability to view and dispute the inaccuracies in their personal credit reports, the act does not apply to business credit. Since business credit reports are much less transparent than personal ones, it is highly recommended that owners manage their business credit file on an ongoing basis, as disputes are harder to initiate and inaccuracies are more difficult to remove. (To learn more, see The Pros And Cons Of Small Business Credit Cards.)
The Bottom Line
The Small Business Jobs Act of 2010 and the establishment of the $30 billion Small Business Lending Fund is providing small business owners and investors with an unparalleled opportunity to invest in their future growth. By providing capital and enhanced loan guarantees, the U.S. government is attempting to relax the credit markets and motivate banks and other financial institutions to lend a portion of the capital that has been reserved due to perceived risks and a bad economy. Providing loan guarantees of up to 90% of the loan principal is encouraging lending, but it's also compelling lenders and the SBA to conduct more diligent credit analysis by scrutinizing the lending criteria that appears in a firm's business credit report. This is also convincing small business owners to manage their business credit and market reputations by presenting an honest representation of their business and its credit quality. (To learn more, check out 8 Tips For Starting Your Own Business.)