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Loans: Interest Rate or Cash Flow

Explore with us if interest rate or cash flow is more important when financing new business equipment.

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Do you think that a conventional bank loan or an SBA guaranteed loan is the best option for a business that wants to finance the purchase of new equipment? Many experienced businesspeople, and even some bankers, might quickly answer that conventional bank loans are a better option. But they shouldn’t be too quick to answer without further investigation. To accurately answer the question, they should first seek to understand if the goals of the company are dependent on maximizing short-term earnings or if the company would be better served by maximizing cash flow and long-term earnings.

Company Goals Matter

If the goals of the company rely on maximizing short-term earnings, then conventional bank loans will beat an SBA guaranteed loan every time because of the differences in upfront fee and interest rates. Banks don’t always charge an upfront fee for conventional bank loans, but when they do the fee is usually 1.0% or less of the loan amount. SBA guaranteed loans require that borrowers pay a loan fee of between 2.5% and 3.5% of the guarantee amount of the loan. Conventional bank loans also carry interest rates that are typically 100 to 300 basis points lower than SBA guaranteed loans. Those two factors will cause conventional bank loans to be the less expensive option for borrowers and will thus help companies maximize short-term earnings.

However, for most small- and medium-sized businesses, their goals aren’t dependent on short-term earnings. Most companies seeking a loan are doing so because they don’t have the cash available to pay in full for the equipment at the time of purchase, or they are conserving their available cash to support future growth. In both of those instances, cash flow is more important to a company’s success than short-term earnings. Maximizing cash flow helps companies reduce the risk of going out of business and gives them the resources to support growth that can maximize future earnings. So, in those cases where the goals of the company are dependent on maximizing cash flow, choosing an SBA guaranteed loan is the best choice for the company.

SBA guaranteed loans will always provide borrowers with higher cash flow than a comparable conventional bank loan. This is possible because when compared to conventional bank loans, SBA guaranteed loans have a higher advance rate against the collateral, and longer amortization periods that allow for a slower repayment of the loan. The cash flow advantages of the higher advance rate and longer amortization period will outweigh the negative cash flow effect of the higher interest rate and loan fee charged on an SBA guaranteed loan.

The table below highlights the cash flow advantages of an SBA guaranteed loan by comparing the cash flow of a $1 million equipment purchase financed with an SBA guaranteed loan versus a conventional bank loan. For this loan, a bank will typically lend only 75% of the purchase price, requiring the company to fund $250,000 of the equipment purchase price. The bank will also only allow an amortization of the principal over a 5-year period. For that same equipment, if the bank utilizes the 7(a) SBA guaranteed loan program and advances 80% of the purchase price (they can advance up to 90%), the company would be required to fund only $200,000 at the time of purchase. The SBA program can also accommodate an amortization of the principal over a 10-year period if the equipment has an adequate useful life. What this means is that the SBA guaranteed loan, with the fees added to the initial loan balance, will result in the borrower having to use $103,000 less cash in year one of the loan, and $317,000 less cash over the first five years of the loan, when compared to a conventional bank loan. The cash flow impact doesn’t turn in favor of the conventional bank loan until year 8 of the SBA loan (long after the conventional bank loan has been paid off).

SBA Chart


About Waypoint Private Capital

Waypoint Private Capital is an investment banking firm that educates and advises middle-market, privately held companies through critical stages of their business' life cycle. Waypoint helps business owners and entrepreneurs sell companies, buy companies, raise equity and debt capital for growth and recapitalization, and plan for a successful exit from the business.

To learn more visit or call us at 608.515.3354 or 918.633.2647 and speak with a Waypoint Private Capital expert.

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Steve Sprindis is co-founder and managing director of Waypoint Private Capital. © 2020 Waypoint Private Capital, Inc. All Rights Reserved.

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