Open Account 
How manufacturers use SBA 7(a) Loans to expand production
A manufacturer approaching full production capacity may have a good problem: demand is beginning to exceed what the business can comfortably produce.
Solving that problem, however, can require significant capital.
Expanding production may involve new machinery, installation, facility improvements, additional inventory, more employees, and working capital before the additional revenue is collected.
For eligible small manufacturers, the SBA 7(a) loan program can provide a flexible financing option because qualifying proceeds can potentially address several components of an expansion rather than only a single asset.
What is an SBA 7(a) Loan?
The 7(a) program is the U.S. Small Business Administration primary business loan program.
Businesses generally obtain 7(a) financing through participating lenders. The SBA provides a guaranty to the lender on a portion of an eligible loan.
Businesses must satisfy applicable SBA eligibility requirements and the lender’s underwriting requirements.
Individual 7(a) loans are currently available in amounts up to $5 million.
What can manufacturers finance with an SBA 7(a) Loan?
Eligible 7(a) uses can include:
- Machinery and equipment
- Permanent working capital
- Inventory
- Supplies
- Furniture and fixtures
- Eligible real estate and facility projects
- Leasehold improvements
- Complete or partial business acquisitions
- Certain eligible debt refinancing
For manufacturers, the ability to combine several qualifying business purposes can be important because production expansion rarely involves only one expense.
Example: What does a production expansion really cost?
Consider a manufacturer operating close to full capacity and enough demand to justify another production line.
The initial estimate is new machinery at $1 million. But further planning identifies additional requirements:
| Equipment | $1,000,000 |
| Installation and facility modifications | $150,000 |
| Additional inventory | $250,000 |
| Hiring and training | $75,000 |
| Working capital during ramp-up | $225,000 |
The complete expansion may therefore require approximately $1.7 million, not simply the $1 million equipment purchase.
This distinction matters.
Financing only the machinery could leave the business responsible for funding another $700,000 from existing liquidity.
A more comprehensive financing strategy evaluates what is required to make the new capacity productive.
Build the production expansion financing plan
Before evaluating financing, map the expansion across five areas.
1. Capacity
What is limiting production today? Determine whether the constraint is:
- Equipment
- Space
- Labor
- Inventory
- Technology
- Working capital
2. Fixed assets
Identify the long-term investments required. These may include:
- Machinery
- Production lines
- Real estate
- Facility expansion
- Renovations
3. Operating requirements
Calculate what will change once capacity increases. Consider:
- Inventory
- Raw materials
- Payroll
- Utilities
- Transportation
- Supplier requirements
4. Ramp-up period
Determine how long it will take before the expansion reaches expected production. Include:
- Installation
- Testing
- Training
- Production ramp-up
- Customer payment terms
5. Working capital
Calculate how much additional cash will be required before increased production generates collected revenue.
Together, these five areas help define the true financing requirement.
Why 7(a) can be useful for a multi-part expansion
The flexibility of the 7(a) program becomes particularly relevant when several eligible uses need to be financed together.
A manufacturer may need equipment but also need capital for inventory and other qualifying expenses associated with growth.
Instead of viewing each component as a separate financing problem, the company can evaluate the project more holistically.
This can also help preserve liquidity.
A company may be able to purchase equipment with available cash, but doing so could leave considerably less capital available to purchase the inventory needed to operate it.
The objective is not simply to finance the largest expense. It is to make sure the company has sufficient capital to execute the expansion.
Don’t overlook the time between production and payment
Increasing capacity does not immediately create cash.
The expanded manufacturer may first need to:
- Purchase additional materials
- Hire or train employees
- Manufacture more product
- Build inventory
- Ship customer orders
- Invoice customers
- Wait for payment
If customers have 60-day terms, a substantial amount of cash may remain tied up even after production has successfully increased.
That is why working capital should be evaluated at the same time as equipment and facilities.
When a working capital line may also be relevant
Some expansion needs are permanent. Others revolve through the operating cycle.
For manufacturers with significant inventory, accounts receivable or contract-related financing needs, the SBA 7(a) Working Capital Pilot may also be worth evaluating.
The WCP provides qualifying businesses with monitored lines of credit of up to $5 million.
Depending on the structure, financing may support qualifying contract or project expenses or advances against eligible inventory and accounts receivable.
That creates an important distinction.
A manufacturer might use longer-term financing for machinery while also evaluating an appropriate working-capital structure for the cash that continually moves through inventory and receivables.
The appropriate structure depends on the business and transaction.
What does a lender need to understand?
A strong financing request does more than identify what the company wants to buy. It explains why the expansion is needed and how the business expects to support the financing.
That may involve information such as:
- Historical performance — Financial statements and tax returns can help establish the company’s operating history
- Current performance — Interim financial statements provide a more current picture of revenue, profitability and liquidity
- Existing obligations — A current debt schedule helps identify existing financing commitments
- Project costs — Equipment quotes, construction estimates and other documentation help define the amount and use of financing
- Demand — Customer contracts, backlog, purchase orders or historical growth may help explain why additional capacity is needed
- Projections — Financial projections can show how management expects the expansion to affect revenue, expenses and cash flow
The assumptions behind those projections are equally important.
Eight questions to answer before financing a production expansion
- What is currently limiting production?
- What demand supports the expansion?
- What is the complete project cost?
- How much additional inventory will be required?
- Will the company need additional employees?
- How long will the expansion take to become operational?
- When will additional revenue become collected cash?
- How much liquidity should remain available after the expansion?
Answering these questions can help determine both the amount and type of capital the business may need.
Start with the expansion, then determine the financing
The starting point should not be: How large an SBA loan can the company obtain?
It should be: What does the company need to successfully increase production?
Once the complete capital requirement is understood, the business and its financial and banking advisors can evaluate whether SBA 7(a), a working-capital structure, another SBA program, or another financing solution may be appropriate.
For manufacturers approaching capacity, early planning can provide more options.
The goal is not simply to purchase another production line. It is to make sure the business has the capital required to put that additional capacity to work.
Sources
- U.S. Small Business Administration. “7(a) Loans”
- U.S. Small Business Administration. “SBA lenders”
