More Small Businesses in 2020 Will Be Eligible for SBA Funding

More Small Businesses in 2020 Will Be Eligible for SBA Funding

The Small Business Runway Extension Act of 2018 was signed into law on December 17, 2019. It’s an amendment to the original Small Business Act that changes the size standards for small businesses. Under prior law, small business classification was measured using the annual average gross receipts over three years. Now, classification will be based on the annual average gross receipts over five years. This is a welcome change in the measurement regime. It means many more enterprises will maintain classification as a small business and thus be eligible for funding and a range of support programs offered by the Small Business Administration (SBA).

Small businesses are the work horses of the U.S. economy. A recent report indicates that they contribute ~44% of annual GDP. Most businesses are “small,” by SBA definition (some 30.2 million or 99.9%) and they employ close to 60 million people, about 48% of the labor force.

Small business enterprises play a major role in many sectors, employing about 86% of the general services work force, about 82% of the construction work force, around 85% of those employed in agriculture, forestry, fishing and hunting, and some 68% of real estate and rental and leasing workers. Eighty-one percent, or 24.8 million small businesses, are “nonemployers”, or “one man shows” in which the proprietor is the only worker and 19 percent, or 5.9 million small enterprises, had paid employees.

What is a small business?
The Small Business Administration (SBA) defines a small business broadly as one having fewer than 500 employees, but there is a “size standard” that may be based on receipts as well as the number of employees. The size standards are the average annual receipts or the average number of employees for a particular number of years. For receipts, the average over the last three years was the crucial metric. As mentioned, the Runway Act has changed that to the annual average gross receipts over five years. An industry classification also applies, which means that two businesses with the same revenue profile in different industries may be categorized differently, one as a small business, the other as not. These industry classifications vary widely.

Agriculture has the most limiting standards. Generally, crop production businesses are only considered small, if receipts are less than $1 million, although for producers of chicken eggs, the ceiling stands far above that at $16.5 million. Forestry and logging operations reach their size limit at $12 million in receipts, while motorcycle, ATV, recreational vehicle and boat dealers are no longer considered small if their receipts exceed $35 million.

The largest small businesses will be found in support activities for oil and gas operations, publishers of software, radio stations, theaters and TV, investment banking and securities dealing, and most insurance businesses, where the receipt ceiling is $41.5 million. In all, the Electronic Code of Federal Regulations lists 64 types of businesses with the $41.5 million ceiling.

For businesses measured by number of employees, that number varies from a low of 100 for home furnishing wholesalers, suppliers of construction materials and others to a high of 1,500 for gold ore mining, petroleum refineries, tire manufacturing and many more businesses. Financial institutions have their own metric. Size is measured by asset value, and up to $600 million in assets is small.

The Runway Act is meant to increase the number of businesses that can bid for government contracts and apply for other benefits offered by the Small Business Administration (SBA). The SBA provides resources to help small businesses increase their chances of success, including a variety of funding vehicles.

SBA Funding Support
The SBA does not provide credit directly to small businesses. However, it does provide guarantees to financial institutions so that those institutions are more inclined to lend to small businesses. The agency has established a framework which banks, credit unions and other lenders can rely on to reduce the risks of lending to small businesses. The SBA also makes it easier for lenders to access capital. The overall aim is to increase the amount of credit available to small businesses.

Loans guaranteed by the SBA are usually comparable to other commercial loans in terms of interest rates and fees. Additionally, some loan facilities are coupled with technical support by SBA staff. Benefits of SBA-guaranteed loans include easier repayment terms and little-to-no required collateral. Loan amounts vary considerably, from $500 to $5.5 million, and, generally, there are very few restrictions on how the funds may be applied. Loan proceeds may be used to finance working capital items, such as receivables and inventory, or fixed assets, including furniture, machinery, equipment, real estate, construction and remodeling.

Eligibility for SBA-guaranteed loans is determined by a number of factors, including source of income, ownership and capital structure, ability to repay, and in terms of size, whether or not the enterprise qualifies as a small business.

Investment Capital
Funding for small businesses is also available from special financial intermediaries associated with the SBA, called Small Business Investment Companies (SBICs). An SBIC is a type of privately-owned investment company that has been licensed by the SBA to provide financing to small businesses.

SBICs provide investment capital to small businesses through debt, equity, or a combination of both. Debt is a loan given to a business, which along with interest, must be repaid. Equity is a share of ownership the business sells to the SBIC, where the proceeds of the sale inject funds into the business.  An SBIC may also choose to invest through a combination of both debt and equity or through debt that is convertible to equity.

A typical SBIC debt investment is made over a 3-year period with principal amounts that range between $250,000 – $10 million, at interest rates between 9% and 16%. Equity investments range from $100,000 to $5 million.

Under state law, an SBIC may be organized as either a corporation, a limited partnership or a limited liability company. If adopting the partnership form, the entity must have at least two general partners who have five or more years of “decision-making” experience as a principal in a private equity fund. But that’s not all; the fund must have a track record that places it “in the upper half of performance for funds of the same vintage year and style” and the fund managers must have “managerial, operational or technical experience that can add value at the portfolio company level.” The general partners will typically make all the investment decisions, as well as manage the fund. And so part of their mandate is to secure capital from general partners. The SBA will then match investors funds, $2 for each $1 invested.

Other SBA Funding and Support Programs
The SBA also provides support in the areas of disaster relief, surety bonds and grants. Disaster relief takes the form of low interest loans to aid businesses stricken by a variety of catastrophes. The agency will also provide guarantees to surety companies that issue surety bonds to small businesses. Surety bonds are guarantees to a client that the business will fulfill its obligations under the contract of work. The SBA’s involvement reduces the risk to the private surety company making the issue of a surety bond more likely. For this service, the agency typically charges around 0.6% of the contract price.

The SBA also helps small businesses gain access to grant funding and educational resources. Programs include the Boots to Business (B2B) Funding Opportunity, an entrepreneurial education and training program and several programs that provide funds for research and small business support, such as the Federal and State Technology (FAST) Partnership Program and the State Trade Expansion Program (STEP).

The Runway Extension Act is a boon to small business. It should help businesses maintain their small status and not lose it after periods of rapid growth. For a few businesses with falling revenues, it may have the opposite effect. They may take longer to drop to small business level. However overall, the small business sector is likely to benefit.