The year 2006 looks to be a year of continuing growth and expansion for the Alaska economy. The economy, which will continue to be fueled by resource development and military spending, promises to provide many opportunities for Alaska's small businesses. As businesses grow, it becomes critical that they acquire new capital to finance this growth. Capital is needed to acquire additional real estate, to purchase new equipment and inventory and to provide working capital.
Adequate working capital is one element of a successful business that owners of expanding businesses often overlook. One phenomenon of a growing business is that the more revenues and profits grow, the more cash-starved the business becomes. This is because most businesses, with a few exceptions such as restaurants, do work and incur costs up front and then typically have to wait 45 days or more to receive cash in payment for the products that are produced. Most businesses invoice monthly, so that creates an initial lag time between the incursion of costs and payment. Then a second lag period comes because most businesses offer payment terms of 30 days.
Covering the costs of payrolls and material and inventory during the 45-day lag period becomes a challenge when a business is growing at a fast pace. A common way to meet this challenge is to take out a term loan to provide permanent working capital. These loans are commonly for a period of seven years and are structured so that the monthly payment stays the same throughout the period of the loan.
Some business owners mistakenly think that a line of credit is the appropriate instrument for financing permanent working capital. Lines of credit are simply glorified credit cards. Banks expected these lines to be used and then paid down to zero at least once a year. A line of credit works best for seasonal businesses, not for steadily growing businesses. Businesses in a rapid growth phase will not be able to make large payments on lines of credit until the rate of growth slows and accounts receivable shrink.
New businesses or rapidly growing businesses often have a difficult time finding any kind of bank financing, and they especially have difficulty finding financing for permanent working capital. Government-guaranteed loan programs provide a good financing source for these kinds of businesses.
There are three primary types of federal loan guarantee programs in Alaska. All of these programs used to provide loans directly, but today they all work through private sector financial institutions to deliver loans. These guarantee programs provide significant benefits both to the financial institutions and to the business borrower. The benefit to the financial institution is that if a loan fails, the government will share in any losses. The benefit to the borrower is that the financial institution has a fairly low limit on the interest rate it can charge on guaranteed loans. Also the borrower is able to amortize a loan over a much longer period of time when it obtains a loan guarantee. Guaranteed loans are can be written for periods of up to 30 years, whereas non-guaranteed conventional bank loans seldom extend beyond 15 years. Most importantly, the guarantee often allows businesses to obtain a loan when often then simply could not obtain a loan of any kind without a guarantee.
The largest and oldest guarantee program is operated by the Small Business Administration. This program is available to all businesses. The most common SBA guarantee program is called the 7(a) program. This program provides a 75 percent guarantee on loans up to $2 million. These loans can be for a term of up to 30 years for real estate, up to 15 years for equipment and up to seven years for working capital. The SBA also has a program, called the 504 program, which is typically used to finance real estate.
The second-largest federal business loan guarantee program is operated by the Rural Development division of the U.S. Department of Agriculture. This program is open to almost any type of business operating in any part of the state except Anchorage. This program typically provides guarantees ranging from 80 percent to 90 percent on loan up to $5 million. In certain circumstances, the loan amount can go even higher.
The smallest of the federal guarantee programs for businesses is operated by the Bureau of Indian Affairs. This program is only open to Native-owned businesses.
As Alaska business owners develop their resolutions for the new year, they should resolve to take time to determine how much new capital they will need to finance growth during the year. They should then start working on a rational financing plan before they get into a cash flow crunch. As they develop these plans, they should consider government-guaranteed loans as one useful tool that can help them successfully grow their business.
David Hoffman is the president and chief executive officer of Alaska Growth Capital, a firm that provides commercial loans and business consulting. He can be reached in Anchorage at (907) 339-6760 or at dhoffman@alaskagrowth.com.
