The United States Department of Agriculture (USDA) loan program is designed to improve the economic health of rural communities by increasing access to business capital through loan guarantees. Loan guarantees from this federal government agency enable commercial lenders to provide affordable financing for rural businesses by reducing lender risk.
All loans under the USDA Business and Industry Guaranteed Loan Program will receive an 80% guarantee from the USDA, up to the maximum loan amount of $25 million. One of the main advantages of USDA loans when compared to SBA loans, is financing is available for projects up to $25 million and there are no caps, so multiple loans up to $25 million are allowed!
When considering if a project is eligible for a USDA loan, a prospective borrower should start by inputting the address into the USDA Income and Property Eligibility Site. Be sure to click on the OneRD Loan Guaranteed tab at the top. In general, rural areas not in a city or town with a population of more than 50,000 inhabitants will be eligible for USDA loans. The borrower’s headquarters may be based within a larger city, as long as the project address is located in an eligible rural area.
Since the focus is the business development of rural areas, many different business entities are eligible for USDA financing. USDA allows applicants to be for-profit or non-profit businesses, cooperatives, federally recognized Tribes, public bodies and individuals engaged or proposing to engage in a business. Individual borrowers must be citizens of the U.S. or reside in the U.S. after being legally admitted for permanent residence. This flexibility of allowing many different applicant types is also an advantage of USDA loans over SBA loans.
USDA Loan Characteristics vs. SBA & Commercial Loans
USDA loans typically offer a 30-year repayment term which is a major advantage of USDA loans over SBA loans. Since the loan must be approved by the lender and the USDA district office and in some cases, the loans also must be approved by the USDA national office, the loan process takes longer which is a disadvantage of USDA loans compared with SBA 7(a) loans with preferred lending partners of the SBA.
All projects require an equity injection of no less than 10% of the total project cost which includes working capital to pay bills in the early stages before the new business is profitable. The percentage of equity injection is determined by the USDA equity injection matrix and could be up to 25% for new businesses. The source of the equity injection can come from almost any source including liquid assets, pledged property, co-borrower liquidity and assets and even grants and subordinated debt.
Collateral must have documented value sufficient to protect the interest of the lender and the agency. Lenders will discount collateral consistent with a sound loan-to-value policy with the discounted collateral value at least equal to the loan amount. The lender must provide a satisfactory justification for the discounts being used. Hazard insurance is required on collateral (equal to the loan amount or depreciated replacement value, whichever is less).
The USDA charges an initial guarantee fee, currently 3% of the guaranteed amount, which can be financed into the loan. There is an annual USDA guarantee retention fee, currently 0.5% of the guaranteed portion of the outstanding principal balance, which is paid annually. The bank will usually build this annual renewal fee into the interest rate of the loan. Reasonable and customary fees for loan origination are negotiated between the borrower and lender and can also be financed into the proposed loan.
Interest rates are negotiated between the lender and borrower. Rates may be fixed or variable. Variable interest rates may not be adjusted more often than quarterly. As a rule, USDA loans typically offer lower annual percentage rates when compared to SBA loans which is another advantage of USDA loans.
The USDA Loan Process
The USDA loan process is a unique process that includes requirements unique to USDA loans. The initial vetting is nearly identical to the SBA loan process. The borrower(s) must submit personal information of all owners with more than 20% equity in the new business and business information about the project that the request is being made for financing. The personal information required includes, but is not limited to, three years of personal tax returns, a personal financial statement, a resume and three years of tax returns of any affiliated businesses the owners own so the lender can calculate a global cash flow ratio.
Each lender will supply an application form that will include a request to pull the owner(‘s) personal credit along with other information giving an overview of the owners and the project. The business information needed includes a business plan, financial projections and a use and sources of funds outlining the loan request.
For new businesses (startups) or expansions of businesses, a feasibility study will need to be completed by a third party covering the topics listed in Appendix A of the 5001 OneRD Regulations. The sections covered in Appendix A are Economic Feasibility, Market Feasibility, Technical Feasibility, Financial Feasibility and Management Feasibility. There also need to be sections including an executive summary, recommendation and qualifications of the preparer. The best option is to contact the lending institution to obtain references or ask if your source is qualified to complete this report.
All projects will require a Phase I environmental report. Projects with new construction or projects that involve an expansion that disturbs ground will need a Phase I, Intergovernmental Review and Environmental Assessment. Expect the environmental portion for these projects to take three months from when the company is engaged. This report can be done concurrently with other things like underwriting and feasibility study. Additional regulations come into play for projects in a floodplain or wetlands.
Underwriting should not take more than two to three weeks depending on the number of loans the bank is processing. During that time the underwriter will communicate directly with the borrower about any questions they have or additional documents needed to complete the loan approval package. Most underwriters are on your side and just want to understand how you are going to operate your business and where your assumptions come from. No need to view this as a hostile situation!
The above graph offers an overview of the USDA loan process showing each step from the initial loan application until the loan closes. For more information, visit www.businessfinancedepot.com.
Paul Bosley is a Managing Member of the Business Finance Depot (www.businessfinancedepot.com)
Published in Woodall’s Campground Magazine in August 2022.