Chapter 6 - How and Where to Obtain Capital

Classification of capital | Four general sources of capital | Banking services | The bankers point of view | Basis of a loan | Use of financial statements | Use of collateral | Importance of looking ahead | Selection of a bank – progressiveness of the banker | the banker’s approach to your problem | availability of credit | size | managerial policies | Sources in the Federal Government | Small Business Administration | The Federal Reserve System | Federal Housing Administration | Veterans Administration

Classification of Capital

Since the present or prospective owner of a food service operation can obtain capital from only investment or loan sources, one proper classification of capital is based on source; that is, does the additional capital represent an investment or a loan? Also, because capital is needed for either short or long term objectives, another classification is the length of time that capital will be utilized.

Short term use of capital is defined for the purpose of this chapter as all types of capital that will be utilized and repaid to the lender or investor within a period of one year. Any money obtained from various capital sources to be repaid in a period of more than one year is regarded as long term use of capital.

The ability to obtain money when it is needed revolves around the basic principle of use and repayment. Capital can very seldom be obtained unless there is a close relationship between the type and effective life of the asset and the use and repayment of the loan or investment. For example, a long term note cannot be obtained for use of short term working capital needs such as rent, wages, and supplies. Similarly, if money is needed to finance the purchase of land, build­ings, heavy equipment or other fixed assets, the capital is usually obtained from long term funds.

Investment or loan capital may be obtained from these four major areas:

1. Individuals such as members of the family, friends and business associates, equipment dealers, purveyors, manufacturers.

2. Forms of business organization. For example organizing the business as a partnership, a limited partnership, or a corpora­tion for the express purpose of obtaining additional capital.

3.  Various types of business firms created for credit purposes such as industrial, savings, savings and loan banks; small loan com­panies, insurance or commercial credit companies.

4. Loan sources in the federal government, including the Small Business  Administration,   Federal  Reserve   System,   Federal Housing Administration, and Veterans Loans.

Money obtained from friends is generally on a short term basis. Members of the family, equipment dealers and manufacturers very often offer a long term loan. Purveyors of food and other restaurant supplies usually give thirty days credit. In the case of equipment manu­facturers credit is obtained through lease arrangements whereby, in many instances, the equipment becomes the property of the lessee at the end of a stated period.

The comparative ease of raising capital which results from the pres­ence of characteristics such as limited liability, permanency, and easy transferability of ownership interests in the corporate form of organ­ization is explained in the chapter on forms of restaurant organization.

The limited partnership is another effective device for increasing both the owned funds and the credit of either the sole proprietorship or the partnership form of organization. The capital contributed by a limited partner is not considered an ordinary loan but as an addition to ownership funds. As a limited partner he shares in the profits instead of collecting a rate of interest. The contribution to the ownership funds therefore expands the security of creditors, thus increasing credit sources. An ordinary loan increases the liability of the firm and con­sequently reduces the line of credit which might have been available before the loan was received.

The limited partnership differs from the partnership association in several important respects, although both may be organized for the purpose of obtaining additional capital. The partnership association is organized by filing suitable articles of association. The ownership interest is represented by shares of stock and must pay taxes as a corporation. Limited partnership, on the other hand, is formed by an agreement with one or more general partners and a limited partner. The limited partnership files and publishes a certificate of limited part­nership for the protection of creditors and is exempt from such taxes as double taxation on income and on the distribution of income.

The third source of loans is from that category of service institutions that provides in addition to other facilities a source of credit to the restaurateur. These credit sources include institutions such as indus­trial, savings, savings and loan and other commercial banks, insurance, commercial credit and small loan companies.

The most important source of credit from these institutions for the prospective owner and the recently established operator is the com­mercial bank. Experience has shown that many borrowers do not understand clearly how to obtain a loan from a bank. The would-be borrower's problem breaks down into two major areas: the informa­tion and procedures required to obtain the loan and the selection of the proper bank.

Banking Services

Banks are, of course, service institutions. Among the major facilities they provide, some of the most important to small businessmen are:

1.  A safe place to deposit funds;

2.  An efficient way to collect checks and drafts;

3.  A source of advice with respect to financial matters;

4.  A means of borrowing money to supplement the funds which the businessman has in his business.

That last function—borrowing money—is discussed in greater de­tail here.

The Banker's Point of View

When lending money, the banker must keep certain firm obligations in his mind. He must comply with the specific laws and regulations which govern the operation of banks. He must also keep prominently before him the debts which he owes his customers in the form of deposits. In the main, the funds which he lends are not his; they have been entrusted to him by his depositors. To fulfill these two obligations the banker is compelled to know as much as he reasonably can about the people to whom he lends his depositors' money. This is where the borrower can be of immeasurable help to his banker—in his own self-interest.

Before a banker is prepared to make a loan he must feel satisfied with the answers to these five questions:

1.  What sort of person are you, the prospective borrower?

2.  What are you going to do with the money?

3.  When and how do you plan to pay it back?

4.  Is the "cushion" in the loan large enough? In other words, does the amount requested make suitable allowance for unexpected developments?

5.  What is the outlook for you, the borrower, for your line of business, and for business in general?

What sort of person is the borrower?—the first question—is by all odds the most important of the five. The character of the borrower comes first. Next is his ability to run his business.

There are few problems on this score where banker and borrower have known each other for many years. Nor are there apt to be obstacles where the business is well established—even though banker and borrower are not intimately known to each other. Experience and the operating record speak for themselves.

But what of the case, where the banker and the prospective borrower do not know each other in advance? What if the business has no long-established record? If these conditions describe your own situation, go in to see your banker and discuss your situation with him. He will want to help you, and he may be able to offer specific recommenda­tions.

For the future, here is a suggestion which may make your banking relations more satisfactory from now on. Whether or not you foresee the need for a bank loan, make it a practice to visit your banker at least once a year. When you do, give him your figures (more informa­tion on this will be covered later). Discuss what happened last year, and go over your plans for the year ahead. Then, should you need to borrow in the future, you have laid a sound foundation and your banker does not have to "start from scratch" to learn what has hap­pened in your business. Nor are you, as a potential borrower, and your banker, faced with the difficult task of understanding each other under the pressure of a request for an immediate loan. The relationship has been established well ahead of time.

You might say, understandably enough: Why doesn't the banker take the initiative in approaching his non-borrowing depositor? Ba­sically the answer is his fear that the client might misinterpret his inter­est as an unwarranted intrusion in his affairs. The initiative, therefore, generally is left to you, the businessman. A good deal of time has been taken on this question of "What kind of person . . ." because it is the most important of the five.

What about the use and repayment?—the second and third ques­tions? These points should be considered together. The banker will always want to know: What is the borrower going to do with the money; and how and when does he plan to pay it back?

The answer to the first of these two questions usually determines the answer to the second. On the one hand, if the loan is made to acquire seasonal inventory or to carry accounts receivable, for example, it should be repaid in a few months. On the other hand, if the money borrowed is to be used to buy fixtures or equipment, the loan may be outstanding for a considerably longer period. It is the earnings on the investment in the latter case, not the cashing of the asset, which will provide the means of repayment.

How can you, as a borrower, go about preparing answers to the two questions? As a first step, before you talk to your banker about a loan, decide for yourself how much money you need, what you expect to do with it, and how and when you plan to pay it back. Then explain your plans to your banker, accurately and in detail, so that he may understand your program clearly.

Is there enough of a cushion in the loan?—that fourth question— is often the cause of honest differences of opinion. The borrower may believe that there is enough cushion but the banker may not. Each may be right from his own point of view.

If the banker is satisfied with the answer to the first three questions, he can make a loan on only one of these two bases:

1. Financial statements setting forth the condition of the borrower;
    or
2. Collateral pledged.

If either one of these two conditions is not met, the banker may run into well-merited criticism from the bank examiners. These examiners have a duty to perform in the interest of the bank's depositors and the public welfare.

Adequate Figures a "Must"

It is worth noting that, although statistics are not available to prove the point, it is probable that banks lend a good deal more money to business on the strength of figures than they advance against collateral pledged. The two basic financial statements they use are the balance sheet and the profit-and-loss statement. Bankers and borrowers have a common interest, not an opposing one, in what these figures show. The businessman is interested in the solvency, the profits, and the growth of his business. The banker wants to make loans to businesses which are solvent, profitable, and growing.

That statement does not imply that bankers invariably insist that profits and growth be achieved in each and every period. There are times in the life of many businesses when both may be well-nigh im­possible, for the time being. In the long-range plans, however, profits and growth, as well as solvency, are common aims for both borrower and banker.

The balance sheet, then, is the major yardstick for solvency, while the profit-and-loss statement is the chief yardstick for profits. A con­tinuous series of these two statements, over a period of time, is the principal device for measuring growth.

Before you ask your banker to lend you money without collateral —just on the basis of your figures—remember that he can do so only if you furnish him with enough information to enable him to form a reliable opinion of the soundness of his risk. It would clearly be unwise for the owner of a ship to ask the master to take the vessel to sea, but deny him charts and navigating instruments. It is equally unwise for a businessman to ask his banker for a loan, but deny the banker the means by which he can steer his course.

When you plan to borrow money, you can do your part toward building an effective banking relationship if you will make available, willingly, to your banker:

1.  Your balance sheets and profit-and-loss statements, prepared by acceptable certified public accountants. This suggestion casts no shadow on the integrity of borrowers. Again to illustrate: The income tax liability is of great interest primarily to the borrower and second­arily to the lender. Income taxes are end figures, the result of the profit-and-loss account and the balance sheet. It is important that such statements be prepared by a qualified, impartial expert.

2.  Other financial data—where needed—in sufficient detail.

3.  Financial reports at sufficiently frequent intervals so that the banker does not have to guess at what is going on in your business.

If you supply adequate figures, the banker is able to do his job more efficiently in two ways: first, in actually making loans; second, in giv­ing reliable counsel on the financial aspects of his customer's business.

Using Collateral

If the loan required cannot be justified by the borrower's financial statements alone, a pledge of collateral may bridge the gap. If the collateral consists of readily marketable stocks and bonds, or the cash surrender value of a life insurance policy, the road is usually smooth. Values are easily established. The legal necessities for effecting a valid pledge, and the margin requirements are commonly understood.

Other types of collateral, however, must be considered in a different light. Values are not always so easily agreed upon. The law with re­spect to a valid pledge often varies from state to state. Moreover, what constitutes a safe margin can well be a matter of opinion, rather than a generally accepted rule. The situation is further complicated by the fact that banking statutes and regulations often put limitations on a bank's freedom of action in this respect. In addition, loans against each of the types of collateral impose a duty on the banker to insist on having more detailed supervision and more frequent follow-ups than if he were lending against periodic financial statements or readily marketable collateral. Therefore, whether your banker will or will not make loans against any or all of the types of collateral discussed will depend on the legal requirements with which he must comply, and on the policies which the bank's directors have set.

Here are two specific observations which are useful to keep in mind despite the foregoing general limitations. First, each type of collateral is good under the proper circumstances. Second, if your banker cannot accept the collateral you have to offer, he will usually be able to sug­gest other responsible lenders who will consider your application.

Types of Collateral

Now for direct mention of the types of collateral which were re­ferred to earlier. They may be summarized as follows:

Securities of Closely Owned Companies: The problem, here, is that the collateral may have to be sold and there may be no established market available. A particular buyer must be found. Sometimes this obstacle can be overcome if a responsible third party will enter into an agreement with the bank stating that he will buy the note and the collateral from the bank should the borrower default.

Commodities or Merchandise: These also make good collateral un­der the proper circumstances. Ready marketability, margin, time of proposed sale, care during storage, and validity of lien are the particu­lar matters to be discussed with your banker.

Machinery and Equipment: In recent years an increasing number of banks have engaged in this type of financing. Whether this be for ac­count of the seller or the buyer, whether it be on conditional sales contracts or chattel mortgage, whether it be with or without recourse or reserve, depends on the individual application. In general the banks engaged in this type of financing feel it necessary that the following conditions be met:

1.  Preferably, the machinery or equipment should be new—not used.

2.  A reasonable down payment is required—say between 25 per­ cent and 33VS percent of cost.

3.  The final maturity period might be as short as 12 months or as long as 60 months, depending on the type of equipment to be financed.

4. The machinery or equipment should permit a ready sale at a fair value in the used or second-hand market.

5.  The estimated profit, or savings plus depreciation, resulting from acquisition should be adequate to repay the loan over the life of the loan.

Real Estate and Buildings: Although a mortgage on real property is the oldest type of pledge known, there are many banks which do not feel that they can take a mortgage on commercial or industrial prop­erty as the sole basis for a business loan. This is more apt to be true in the very large cities than it is in smaller centers. The reasons for this point of view—where it is found—are numerous and technical. In the main, however, they relate in part to banking laws and regulations which govern this type of advance in detail, and in part to overall considerations of policy.

Government Contracts: During World War II, the means by which the proceeds of government contracts could be used as bank collateral were greatly broadened. These means are again largely in force. The requirements to be met are determined by the related acts of Congress and the regulations set up by the government agencies and depart­ments concerned. Suffice it to say that if you have government con­tracts which need financing, discuss the matter with your banker.

Importance of Looking Ahead

At the beginning it was stated that in deciding on a loan, the banker must satisfy himself on the answers to five important questions. Four of these questions have been covered. Now consider the fifth one—the outlook for the future.

Loans made today are to be paid back on some tomorrow. There­fore, when a banker lends money to a business, he must form an opin­ion about the future of the borrower, and the borrower's line of business, and of business in general, for the period of time covered by the loan. Frequently he will not state that opinion to the businessman, but it is there, nonetheless. Any estimate of the future is hazardous, and the more light that can be brought to bear on it the better.

With respect to the outlook for your own enterprise, you should have more information than anyone else. But your plans for the future, if kept to yourself, can be of no help to your banker.

While lenders endeavor to keep abreast of developments in the lines of business which they serve, they cannot ordinarily be so well posted as are the managers engaged daily in those fields. New prod­ucts, new machines, new methods of distribution and marketing, and new packaging can alter the course of a whole field of business as well as the individual concerns in that field. An exchange of information between banker and businessman, with respect to developments af­fecting the borrower's line, is helpful to both individuals.

What lies ahead for business in general is a complex matter. No one can be sure that his view will prove to be correct. Both the borrower and the lender should be interested in the other's opinion. The chronic pessimist is no better as a banker or businessman than is the chronic optimist. What the banker is looking for in the businessman is a sense of balance. The businessman has the right to expect the same quality in his banker. But if the two never trade their ideas on how things look, neither one will have the opportunity to get a "feel" of the other's mind. Without this "feel," it is difficult to achieve that mutual under­standing which is essential to a well-rounded banking relationship.

The selection of a bank involves the choice of a banker and under this circumstance revolves around the problem of sizing up a banker. There are five main points to consider: progressiveness, attitude toward your business, credit services offered, size of bank, and manage­ment policies of the bank.1

Is the Banker Progressive?

Physical appearance can give some indication of a bank's progres-siveness, or lack of it, and in this way can be a factor in choosing your banker. But don't let "eye appeal" alone control your judgment. Un­questionably, up-to-date quarters which are clean, attractive, and fur­nished with modern equipment may give some indication as to the banker's desire to meet and please new customers. Likewise, the presence of a handy parking lot, sidewalk teller windows, air condi­tioning, and modern

1 The information is condensed from Management Aids for Small Business, Small Business Administration, Washington 25, D.C.

lighting may give clues to the bank's progressiveness. Nevertheless, it is always important to appraise physical features with balanced judgment, taking into account the real needs and pos­sibilities of the particular situation. For example, a big city bank may find it impossible to provide a parking lot right next door; a small country bank may have no need for sidewalk tellers; and banks in cool, dry localities may get along satisfactorily without air condition­ing. So try to get a well-rounded picture of both the bank and the banker before you make a final estimate of progressiveness.

What about a bank's employees? Are they reasonably young, inter­ested in your problems, active in civic affairs? Has your prospective banker called on you and solicited your business, or does he seem to give you a cool, remote treatment as if he would be doing you a favor to accept your account?

Is the banker known for his capacity to meet changing conditions effectively? Many bankers used to be interested only in large corporate accounts. But lately most of them have found that their best customer is the average "man on the street." This discovery has led to the adop­tion of many new banking services. Among these are low-cost personal checking accounts, bank-by-mail programs, night depositories, per­sonal loans, and installment credit for small business concerns.

One of the best tests of a bank's acceptance of progressive ideas is the character of its advertising. Is it fresh and imaginative, or does it tell you to do business with the bank merely because it is a "sound institution" and has been in existence longer than any other bank in town? By and large, a bank is as good as its present officers, and that has very little to do with the executives who were in charge many years ago.

How Does the Banker Approach Your Problems?

When you go in to have a talk with a banker, you can learn a lot about how he would approach your problems by his attitude toward you and your business and by the kinds of information he considers important. An interested, helpful approach on the part of the banker can be a significant factor in selecting the most suitable bank for your business.

First of all, does the banker regard the prospective relationship as one in which he would help you to become a better manager? If he is an efficient, progressive banker, he will be interested in helping you in this way and in building a continuing relationship that would mean profitable business for the bank over the years. His enlightened self-interest is to your advantage, too, because it leads to a healthy growing bank.

In this connection, it is logical for a banker to be interested not only in having your borrowing business but also in your account as a de­positor. Both aspects of banking are "two-way streets." In the first place, as a depositor you have a safe place to keep your money plus the convenience of being able to transact business by check. At the same time, your deposited funds give the banker reserves against which to make loans. In the second place, as a borrower, you gain access to the capital you need to operate your business. At the same time the banker earns income in the form of interest on each dollar he lends.

In regard to selecting your banker with the aim of building a per­manent relationship, keep in mind that it doesn't pay to move very frequently from one bank to another—especially in days of relatively tight credit. The banker is only human, and you should understand his resentment at losing an account to another bank because of a differ­ence, for example, of one-quarter of 1 percent in the interest rate charged on a loan. If you were repeatedly to try one bank after another, you probably wouldn't be welcomed back with open arms by one of your former bankers. He would recall his efforts and services, and the hours he spent discussing your problems with you. And he would figure that these things deserved some reciprocity.

An alert banker will want a great deal of confidential information from you. Good banking practice demands that he protect himself, his depositors, and you. Therefore, you should expect him to look care­fully into your records, needs and plans. Ideally, he should want to know as much about you and your business as you do yourself. Of course, while the banker is entitled to all this information, he is at the same time obligated to keep it in the strictest confidence. His profes­sional discretion should be as completely reliable as that of your doctor.

In deciding upon a banker to do business with, don't think of the preparation of detailed financial statements as a nuisance imposed upon you by the banker's unreasonable love for statistics. Take into account the fact that he cannot live with your business day by day, as you do, and that he can judge your financial position and progress only through the information and figures which you give him.

As a new customer, you should invite him to go a step beyond the examination of your financial statements and make a visit to your place of business. In this way you can get to know him better and, at the same time give him data with which he can serve you more satis­factorily. Usually, if he is at all interested in your business, he will welcome the opportunity.

When you are in the process of establishing a new banking connec­tion, be prepared to show the banker that you're honest, and that you have the capacity to run your business successfully. In this regard, you should not feel put out when he checks with the mercantile agencies to see how you have paid your obligations in the past. And you should assume that he will ordinarily make inquiries in the trade and will ask for the experiences of other banks with which you have done business.

Can You Get the Kind of Credit You Need?

In the days ahead, a strong credit relationship with your bank may be a vital factor in the success of your business. With a heavy demand for funds and the possibility of rising interest rates, banks may tend to be increasingly selective in seeking loans for income. Thus it may be more complicated than in the past for businessmen to establish new lines of credit; so be sure your banker understands your particular needs and is prepared to service them.

If seasonal accumulations of inventory are your problem, a loan against public or field warehouse receipts may be the answer. Although some banks still remain skeptical of field warehouse credit, most of them will lend against salable merchandise with an established market.

If your business is new, or is involved in a major expansion, you may need to supplement your capital with "term" credit until such time as earnings can be accumulated for use in the business. Or perhaps you have reached a disagreement with your partner and it's a case of buy his interest or sell yours, but you'd rather buy him out. It's going to take awhile for you to pay off, but if you've got a good earnings record or reasonably demonstrable prospects, you've got something to talk about. Will the bank consider a term loan?

How Big is the Bank?

Much of the time it won't be important whether you're doing busi­ness with the biggest bank in town or the smallest, but sometimes there's an advantage in size. Remember that banks are regulated by government agencies, and one of the most important regulations re­stricts the amount they may lend to any one customer. This amount is related to the bank's capital and surplus. You will want to know that your maximum credit requirements fall well within your pro­spective bank's "legal limit," or at least that the bank has correspondent relationships with other banks where your "excess" loans may be placed. Otherwise they may find that you have used all the credit your bank can make available, and no one else is interested in your addi­tional needs.

Still another advantage in size is specialization. Many small banks don't have a trust department, and you may require the services of one in connection with your will, with escrow arrangements, or with the management of your investments. Perhaps you do a little export business. Does the bank have a foreign exchange department? Or if your dealers sell on installment terms, you may be able to arrange for your bank to handle their installment paper—provided, of course, that the bank has a department for this purpose.

Through this same service, dealers may be able to get "floor plan" accommodations for your merchandise so that bills can be discounted, and so that you need less capital tied up in receivables. The procedure is essentially a form of inventory financing. It works this way: The manufacturer ships his product to the dealer with the title going di­rectly to the dealer's bank. When the goods arrive on the dealer's selling floor, he then gets a bank loan which he uses to pay the manu­facturer promptly. Thus the bank finances the dealer instead of the manufacturer having to do so. Many banks, however, do not under­take this sort of lending service.

Sometimes prestige also goes along with size. After all, it may be as­sumed that one bank is bigger than another because more people do business with it. This may not be important to you and need not be decisive in your considerations. It may mean, however, that more con­tacts are available to you through your bank. At least it's a point not to be ignored.

What Are the Bank's Management Policies?

In the process of selecting your banker you should make sure you have a reasonable understanding of the bank's management policies.

One of the areas of policy which you would do well to know some­thing about is the system of organization which the bank uses, since that system may affect your banking relationship.

Broadly speaking, there are three kinds of banking set-ups through­out the country. The first type may be called a unit system; in it a bank has just one office and does business in just one location. The second type could be called a branch system; here, there is one central bank with one or more branch offices located at different points in the same community as the main office, or even in other communities. The third type might be termed a chain system; in this case, there is a central holding company which controls several subsidiary operating banks in various localities. Variations in how these three systems function stem from state banking regulations. The situation in your own area will depend to a large degree on the laws of the particular state in which you live.

Which of the systems provides the best service to small businessmen is a debatable question. Moreover, it is not the most significant point in connection with picking out a good bank; the important point is not the system, but whether or not the particular bank is suitable for your particular business needs.

In this regard, you might also do well to investigate how deeply your prospective banker is concerned with the growth and prosperity of your local community, and to what extent the management is local and permanent. Another point worth looking into is the speed and flexibility with which decisions can be made in your local area. Here again, the banking system is less significant than the management poli­cies of the individual bank in question.

In recent years, bank failures have been only a scattered few, and those have not involved large sums of money. Times have been good, and banking regulations more rigid. In addition, most deposits today are insured by the Federal Government through the Federal Deposit Insurance Corporation. Confidence in the banking system is justifiably widespread, and there is every reason to expect that it will continue.

Yet it is only common prudence to consider the safety of funds in a bank with which you plan to do business. Unfortunately, no sure measure of the safety element is available to the average small busi­nessman. There are, it is true, several statistical approaches to the analysis of a bank's strength. The ratio of deposits to capital funds helps to establish the margin of protection for depositors. The ratio of "risk" assets to capital suggest the extent to which a bank may sus­tain losses without endangering its depositors' funds. The existence of adequate reserves adds strength to a bank's position. But all these analytical tools are rather technical devices with which many small businessmen are unfamiliar. In addition, they fail to take into account the most important factor of all—management. Your most reliable indication, then, is the combination of integrity, experience, ability, and initiative in the people who run the bank. Good management will usually produce a reliable and progressive bank, just as it will usually produce a healthy business.

Finally, once you have started a satisfactory banking relationship, you will want to continue close consultation with your banker. To get the greatest benefit from this consultation, keep the banker informed on new developments in your business, and keep him supplied regu­larly with complete and current financial statements—even at times when you have no need for bank credit. Continuity of information en­ables your banker to handle credit inquiries intelligently, increases his confidence in you, and makes it possible for him to meet your require­ments as they arise.

Although your business may be perfectly healthy, a good "financial doctor" is a handy person to have around. So choose your banker thoughtfully and objectively, and once you have chosen him, do your utmost to make the relationship a satisfactory and profitable one for both of you.

The last category of loan sources is that of the Federal Government. This category includes sources such as the Small Business Administra­tion, the Federal Reserve System, the Federal Housing Administration, and Loans to Veterans. Most restaurateurs do not realize the many Federal agencies that are authorized to make, guarantee or insure loans. One successful operator borrowed close to $150,000 from a single agency in the Federal Government to finance his operation. Each agency is authorized to give a certain type or classification of loan and although you may not be eligible for assistance from one agency you may be able to obtain another type of loan or open up other credit sources through the device of governmental guarantee or insurance from another agency.2

The business loan program of the Small Business Administration is expressly designed to assist small enterprises—manufacturers, distrib­utors, and service establishments—which are independently owned and operated and not dominant in their field. (Disaster loans are also granted to business concerns which have suffered damage from storms, floods, and similar catastrophes and whose areas have been designated "disaster areas" by SBA.)

SBA's business loans are designed to enable small business concerns to finance plant construction, conversion, or expansion, including the acquisition of land; to provide for purchasing equipment, facilities, machinery, supplies or materials; to furnish working capital to be used to manufacture articles, equipment, supplies, or materials for war, defense, or essential civilian production, or to insure a well-balanced economy.

Who May Qualify: Small businesses which are unable to obtain from private lending sources the intermediate- and long-term credit required for general purposes and normal growth.

In addition to the fundamental requirements for government loans, an applicant for an SBA loan must meet these requisites:

1.  The applicant must be of good character.

2. He must show evidence of ability to operate his business successfully.

2 Condensed from Management Aids for Small Business, Small Business Administra­tion, Washington, D.C.

3.  He must have enough capital in the business so that with the SBA loan it will be possible to operate on a sound financial basis.

4.  On a term loan—one repayable in installments over a period of several years—the past record and future prospects of the busi­ness must show sufficient probable future income to provide reasonable assurance of repayment.

Loans will not be authorized to finance recreational or amusement facilities; to pay creditors when such payment would solve pressing financial problems only temporarily; to effect change of ownership in a business; to provide capital to a concern which is primarily engaged in lending or investment activities, in newspaper and magazine publi­cation, in radio and television broadcasting; or to furnish funds to firms which derive substantial income from the sale of alcoholic bev­erages or from gambling.

The maximum loan to any one borrower is $250,000; the maximum maturity, 10 years.

SB A offers three types of loans:

1. Bank participation. Purpose: Through the bank participation plan, SB A cooperates with private financing institutions in meeting the credit needs of small firms. Often a bank is willing to make a loan to a small firm if SBA participates in it, i.e. purchases a share of it. SBA may participate up to 90 percent of the amount of the loan. This par­ticipation may be immediate or deferred, as the bank may elect. The agency cannot enter into an immediate participation, however, if a deferred participation is available. In both types of participation loans the applicant usually receives disbursements from the bank and makes repayment to it. Terms: On an SBA participation loan, the participat­ing bank makes the loan and determines the interest rate to be charged, with a minimum rate of 5 percent annually on the SBA portion of the loan.

Where to Apply: If a bank or other financial institution will make a loan conditioned on SBA purchasing a deferred participation, the ap­plicant files with the bank its application and necessary supporting data, and the bank applies to SBA for the participation agreement. However, if the bank agrees to make the loan, conditioned on SBA purchasing an immediate participation, the applicant must file an ap­plication on SBA Form 4 at the SBA office serving the territory in which the applicant's home office is situated. The same procedure must also be followed if the bank is unable to make a loan on any basis and a direct loan is desired from SBA. In either case, while it is not re­quired that the application be presented in person, it is always de­sirable for the applicant to discuss his situation personally, when possible, with an SBA financial expert. No charge is made for informa­tion and counsel furnished by SBA in connection with the preparation and filing of an application or for other assistance with financial man­agement problems.

2. Direct Loans. Purpose: Such loans are made by SBA to provide assistance where the extension of credit by private banks alone or jointly with SBA is not possible. Terms: The interest rate is 6 percent. Where to Apply: Application forms should be filed at the Regional or Branch Office of SBA nearest to the applicant's home office.

3. Disaster Loans. Purpose: These are made, in areas designated by the SB A Administrator, to aid victims of floods and other catastrophes. Terms: Interest on these loans for the purpose of the acquisition, con­struction or restoring of home or personal effects is 3 percent. Interest on such loans for purposes of acquisition, construction or restoring of business facilities and inventories is 5 percent. Loans for housing may have maturities up to 20 years but other disaster loans are limited to 10 years. Where to Apply: File application forms at nearest SB A Regional or Branch Office. For speed in handling, the SBA Regional Directors have been given authority to approve disaster loans in amounts of $10,000 or less.

The Federal Reserve System

The Federal Reserve System consists of a Board of seven Governors supervising the 12 Federal Reserve Banks, their 24 branches, and some 6,700 member banks. While the principal loan function of the System is to extend credit to member banks, the System also has an industrial loan program and a V-loan program (a loan guarantee pro­gram to expedite defense contracts).

Loans to Established Commercial and Industrial Businesses. Pur­pose: To provide working capital for such businesses when the borrower is unable to obtain needed financial assistance from the usual sources. Loans cannot be made for the purpose of paying off debts. This program has not been very active for some years. Terms: The great majority of these loans (under Section 13 (b) of the Federal Reserve Act) are made through financing institutions—banks, trust companies, mortgage companies, and the like. Very few loans are made directly. The interest rate on direct and indirect loans varies from 2lA percent to 5Vi percent depending on the particular Federal Reserve Bank. Maximum maturity is 5 years. The limit on the amount of loans or commitments that can be outstanding is about $166,000,-000.

Loan Sources in the Federal Government

Where to Apply: At any bank or lending institution or direct to one of the 12 Federal Reserve Banks or 24 branches throughout the country.

Under the Housing and Home Finance Agency are found a number of loan functions. It must be remembered that legislation now pending may effect some changes and additions in the program outlined below:

Federal Housing Administration

The Federal Housing Administration provides insurance against loss on various types of loans made by private lending institutions for housing purposes. Purpose: To encourage private lending institutions to finance needed repairs to homes and other property and construc­tion of new homes and small nonresidential structures, and to encour­age improvement in housing standards and conditions. Terms: A matter for the lending institution to decide, but the general terms of the loan (interest, down payment, and the like) must be examined by the FHA before approval for insurance. Where to Apply: To any lending institution approved by FHA for the type of loan desired.

Property Improvement Loans and Nonresidential Structures. Mort­gages and property improvement loans insured by the FHA provide for repayment in monthly installments covering all charges. The mort­gage insurance premium is computed at V2 of 1 percent annually on outstanding balances of principal. Loans for general home repair pur­poses may not exceed $2,500 or have a maturity in excess of 3 years; those for repair or conversion of multifamily structures may be in amounts up to $10,000 and have a maturity of 7 years. Loans for the building of new nonresidential structures may run up to $3,000 in amount and have a maturity of 3 years.

Veterans Administration

The VA guarantees or insures various types of loans made by pri­vate lenders (banks, savings and loan associations, and the like) to eligible World War II and Korean War veterans. In some cases, it also makes direct loans to them. Purpose: To enable the acquisition of home, farm, or business real estate, supplies and equipment, and work­ing capital. Terms: The loan may be short-term (under 5 years) or long-term (amortized) loans. If the loan matures in less than 5 years, no payments on principal are required until the end of that period. With a long-term loan, a definite monthly payment is agreed upon, through which the borrower can pay off the principal plus the interest over the period of the loan. Down payments are generally lower than required by State laws because of VA backing.

The loan may be either guaranteed or insured by the VA. Generally, long-term home loans—96 percent of them in fact—are guaranteed, whereas short-term non-real estate business and farm loans tend to be insured loans, and are more advantageous. If guaranteed, the interest rate on the loan may not exceed AV2 percent per annum. If insured, 15 percent of each loan is credited by the VA to an insurance account of the lender from which he is paid in case of default. The interest rate on a non-real estate, insured loan may be as high as 5.7 percent per annum simple interest or the equivalent 3 percent discount. Where to Apply: Application for VA loans should be made to banks and other private lending institutions.

Real Estate Loans. A home or business real estate loan may be re­paid up to 30 years and a farm real estate loan up to 40 years. The VA may guarantee 60 percent of a loan for the purchase or construc­tion of a home up to the maximum of $7,500. Real estate loans for farm or business purposes may be guaranteed 50 percent up to $4,000. The purchase price of real estate, or other property, may not exceed the reasonable value as appraised by the VA representative.

Non-Real Estate Loans: These are for the purchase of property other than real estate, such as machinery, tools and equipment, and for working capital required in the operation of a farm or a business. This type of loan may be repaid in up to 10 years and may be guaran­teed by VA up to 50 percent of the amount of the loan or a maximum of $2,000.

Direct Loans: The VA makes direct loans to veterans in isolated areas where private lending institutions will not make the loans. Such loans may go up to $10,000 if the veteran has not used any of his loan entitlement, at AV2 percent interest. The security is, generally, the property acquired by the veteran. Additional collateral may be de­manded by the VA in some cases.

Note: While a veteran may transfer or sell the property purchased with a VA loan to either a veteran or nonveteran, he generally remains liable for the debt. He should, therefore, try to have the loan paid in full by the purchaser of the property.

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