periodic collection of premium fees.13

The SBA also authorizes the participating company to impose an application fee upon the small business firm applying for a lease guarantee. At present, the application fee charged by participating companies ordinarily amounts to $100, payable at the time of the acceptance of the application for processing.

Requirements to Minimize the Risk of Default 14

The SBA is not permitted by Congress to issue any guarantees for small business leases without first determining that there exists a reasonable expectation that the small business concern can perform the covenants and conditions of the lease. In order to minimize the financial risk assumed under a guaranteed lease, the SBA requires that an escrow account be established to assure payment of any installment of rent for which the tenant is in default. The tenant pays an amount into escrow not to exceed one-quarter of the minimum guaranteed annual rental required under the lease. If no default occurs during the term of the lease, the escrowed funds are applied with accrued interest toward the final payments of rent due under the lease. The SBA lease guarantee program fixes three month's escrow as covering an adequate length of time to allow the landlord to secure vacant possession of the property, restore the premises, and install a new tenant.

Upon the occurrence of a default under the lease, the landlord must notify the participating company or the SBA within 30 days. He must utilize the entire period, for which there are funds available in escrow for payment of rentals, in a reasonably diligent effort to find another qualified tenant before he can enforce any claim under the lease guarantee program. No claim can be made or paid under the guarantee unless such an effort is shown to have been made, and the escrow funds have been exhausted. Default by the tenant causes a forfeit in the escrowed funds, and any portion of the

13 Lease Guarantee Program, op. cit.

14 This section based on Lease Guarantee Program, Volume II.

lord as liquidated damages in order to restore or upgrade the property. When the landlord resorts to the use of the lease guarantee, he must take prompt action to terminate the occupancy of the tenant in default. He must secure vacant possession and make any repairs to the property as are necessary to restore its original condition, ordinary wear and tear excepted.

If the landlord or the participating insurance company succeeds in finding a new tenant, and files a claim for default, he must give vacant possession to the SBA as successor in default with the right to rerent the premises to any other tenant on whatever terms are satisfactory to the SBA. The SBA becomes the substitute tenant in possession so as to limit the period of the vacancy for which the SBA is required to pay rent. The SBA also acquires from the landlord the right to collect any rentals which are in arrears from the tenant in default.

As another hedge against risk, rent to the owner of the property in excess of the minimum rent specified in the lease, such as an overage on a percentage of sales, is required by the SBA to be deducted from the total rent guaranteed over the term of the lease. Such deductions shorten the term over which the total rent to be paid is guaranteed.

Both the private insurance company and the SBA make an effort to appraise the risk of default associated in guaranteeing the lease performance of the small business firm. The insurance company requires submission of information from both the tenant and the landlord. The small business firm is required to furnish information about the type and ownership of the business, its capital structure, and the management qualifications of its operators. The application is accompanied by financial statements, and a resume of the history of the business with information on its products, area of distribution, competitive ranking, and the responsibilities of its owners and operators. The insurance company also requires the landlord to furnish information about the leased premises and its location. A copy of the lease, an appraisal of the fair rental value of the premises, a description of the

the landlord, and a current commercial credit report on the prospective tenant also accompany the application.

The SBA does a separate appraisal of the reasonableness of the risk associated with the small business firm's lease, before making a commitment to guarantee the lease. The SBA has developed a risk-rating system to enable its field personnel to grade the leases presented for guarantee according to the risk involved. The major sources of risk which the SBA analyzes are (1) the ability and experience of management of the small concern, (2) the financial position or structure of the organization represented by the leasee, (3) the viability of the location or premises being rented, and (4) the appropriateness of the terms of the proposed lease. The SBA also requires that the firm meet the definition of a small business concern by being independently owned and operated, and of not being dominant in its field of operation. Number of employees and dollar volume of business are among the criteria used in determining whether a tenant qualifies as a small business concern. The criteria varies from business to business reflecting the different characteristics of each industry. Eligible premises include, but are not limited, to downtown buildings, shopping centers, industrial parks, warehouses, and free standing wholesale or retail outlets.

The Prospects for the Lease Guarantee Program

The prospects for the SBA lease guarantee program will be determined by the number of small business concerns of the type eligible under the lease guarantee program that are likely to demand new locations in the next few years, and the capability of these firms to sustain a profitable level of operations in their new locations. The demand for new business locations will be generated by three groups of small business concerns: (1) those with newly-opened operations, (2) those displaced by government programs such as urban renewal and highway department, (3) and all other firms that desire a new location for one reason or another.

Table 2 gives an indication of the growth in the number of business firms in the United States. The total number of

roughly 5,335,700, or some 289,200 more firms than were in operation in 1963. By 1976, the number of business firms is projected to be 5,655,800, or an average of 56,960 new firms to be added in each of the years until 1976. Firms in the retail trade are the largest single category in the population of business firms. The number of retail firms was estimated to be 2,115,500 at the end of 1966, or some 83,500 more firms than in 1963. The projection of the retail firm population for 1976 suggests that approximately 15,100 new retail operations will be added nationally in each of the next few years. The prospects for growth in the number of firms are particularly high for business firms in the service industries. Their number increased by over 102,000 between 1963 and 1966, and the projection for 1976 suggests the addition of 149,700 new firms in this category. The SBA lease guarantee program is obviously designed to assist great numbers of these new firms, particularly in retailing, to acquire desirable locations, provided the management of these new firms has sufficient experience to qualify for a lease guarantee insurance policy.

Table 2 Business Firm Population by Major Industry Divisions (In Thousands)

Year

1963

1966*

1970**

1976**

* Estimated **Projected

All Service Retail Wholesale All Industries Mfg. Industries Trade Trade Other 4,797.0 313.0 942.0 2,032.0 332.0 1,178.0 5,086.2 325.4 1,044.6 2,115.5 354.2 1,246.5 5,335.7 339.5 1,101.6 2,189.1 375.2 1,330.3 5,655.8 353.4 1,194.3 2,267.1 403.9 1,437.1

SOURCE: Status and Future of Small Business, Hearings before the Select Committee on Small Business, United States Senate, 90th Congress, First Session, p. 75.

Studies of small business in the United States have shown that the first two years of existence are the hardest, and a firm that survives five years has an excellent chance of continuing as long as the owner lives or as long as there is any demand at all for the product or service. Small businesses that have been displaced, however, show a much higher discontinuance or closing rate than if left alone. A survey of 50

Renewal Administration in 1963 reported that 64.7 per cent of all displaced businesses re-established operations while 35.2 per cent discontinued operations, thus indicating the latter firms were severely hit by displacement.15 The firms that relocated did so in the same city and occupied the same amount of space, but at double the square foot rent. The problem is critical when its magnitude is considered. A 1964 House Public Works study estimated that about 18,000 businesses would be displaced annually from 1964 to 1972.16 At least 60 per cent of these business displacements resulting from forced relocations are small businesses as defined by the Small Business Administration.

Current projections available to the SBA for federal programs which cause displacement indicate that a total of some 13,000 business displacements will occur in each of the next five years. If 60 per cent of such displacements are small businesses, then 7,800 small business concerns will be adversely affected each year.17 The availability of the lease guarantee program should help to reduce the per cent of displaced business firms which presently cease operations rather than relocating.

In a special tabulation prepared by the Bureau of the Census for the Senate Small Business Committee, an estimate was made of the number of establishments in several major retail lines that obtained new business locations in 1962. The Bureau of the Census estimated that some 61,050 retail establishments acquired new business locations in that year. Single unit independents accounted for 47,500 of the retail establishments at new business locations. In specific lines of retailing, single unit establishments occupied 70 per

15 Relocation: Unequal Treatment of People and Business Displaced by Governments (Washington: Advisory Committee on Intergovernmental Relations, June, 1965), pp. 53-55.

16

Study of Compensation and Assistance for Persons Affected by Real Property Acquisition in Federal and Federally Assisted Programs, Printed for Use of Committee on Public Works, U. S. House of Representatives, 88th Congress, Second Session (Washington: U. S. Government Printing Office, 1964), p. 258.

17 Lease Guarantee Program, Proposed Operating Plan, Vol. I (Washington, D. C.: Small Business Administration, 1967), Mimeographed,

p. 12.