The news is filled with quotes from government officials exposing the critical role small business plays in our economy. Articles talk about the billions in government dollars directed toward supporting them. However, before you stake your claim on these funds, you should understand the assumptions the government has about them.
Having made several trips to Washington D.C. to advocate for local businesses, I have asked many government officials to define the term “small business.” The image most government officials have when they think of them is that it:
Has been around for ten years or more
Employs several dozens to several hundred employees
Has continued to maintain a good credit history despite changes in the economic conditions.
As you can see, this definition contrasts strongly with what everyday people, and business owners themselves, think of when they define the term. We more often define a small business as employing only one or two employees, generally, all having an ownership stake in the business, and frequently struggling to achieve or maintain profitability. Government officials tend to define these businesses as non-employer or micro-businesses.
Currently, the government’s stimulation initiatives generally fall into one of two broad categories: loan guarantees and funding infrastructure projects.
Small Business Loan Guarantees:
A large portion of the government’s stimulation initiatives is for loan guarantees provided through the Small Business Administration (SBA), which is not a direct lender to businesses. Banks are the actual entities that often loan money to businesses.
The SBA helps banks feel more comfortable loaning money to small businesses by offering the bank a loan guarantee if the loan goes bad in the form of an insurance policy that the borrower pays. Since banks are the direct lenders, the bank is the one that has to feel comfortable with the business’s ability to repay the loan. With all its influence, the government is not in a place to force banks to make loans they do not feel are prudent.
However, one of the real values that I think the SBA brings to the small businesses community is the ability within the 7(a) program to buy out a minority partner that wants out of the successful business. One of the early-stage funding options that I share with many clients who have an LLC and need funding is to reach out to a high-income earner, such as a Doctor or Lawyer, and encourage them to invest in their new venture simply to claim the losses on their income taxes. With an LLC you can use the operating agreement to grant this investor 100% of the loss which they can use to offset their taxable income from other sources such as their high-income salary. A business can stipulate in its operating agreement any level of decision-making involvement the investor may have, if any, and the proposed exit strategy. Once the business is successful and the business’s value has gone up the founder can use the SBA 7(a) program to get an SBA loan to buy the high-income investor out at the new and higher valuation.
The SBA 7(a) program offers 100% financing (no down payment) if both of the following conditions are met:
Purchasing shareholder, generally the founder, has been in the business for at least 2 years and owns either an equal or greater percentage of the business then the existing shareholder.
Prior to purchase, the company is not leveraged more than 9 times on the last interim and fiscal year-end balance sheet.
In addition to money directed toward lending, the government directly stimulates a special class of businesses by creating government-funded projects. Most visible amongst these types of projects are infrastructure projects such as highway projects. As you might imagine, competition for these jobs is fierce and most are awarded to prime contractors that are larger, well-established companies.
Infrastructure Set-Asides:
For a smaller business to get a piece of the government’s infrastructure dollars, the business generally needs to be owned and controlled by one of the many minority classifications defined by various government entities. Most government contracts have some portion of the overall budget that is awarded to a prime contractor that must be spent contracting for products or services provided by a small business with a recognized certification.
All government contracting agencies recognize the small business certification called a Disadvantages Business Entity (DBE). To qualify as a DBE, the principal business owner needs to own 51% or more of the business and to be both economically disadvantaged as well as socially disadvantaged.
The criteria for the principal owner to be considered economically disadvantaged are:
Less than $1.32M net worth – excluding home and an ownership interest in a firm
Less than $350K in adjusted gross income
Less than $6M to total fair market value of all owned assets
No excessive assets like a yacht or luxury vacation home
To be considered socially disadvantaged, the principal owner needs to consider themselves as a member of one of the following social groups that have a history of some level of discrimination:
In addition to being a minority business, a Service-Disabled Veteran-Owned Small Business (SDVOSB) is another certification that is recognized by federal and most state agencies.
So while the government may understand the importance of small business in the overall economy, its definition often differs from the way most entrepreneurs may define them. As a result, the methods in which the government can inject money are primarily limited to guaranteeing loans and creating projects for a narrow slice of the business community.
Can you stake your claim on government small business funds?
