Tribes and tribal members need to be careful when borrowing money to fund their businesses.
Getting a loan from the wrong source can result in debt repayment terms that can cripple a business or even cause it to collapse.
Prudent financing allows a business to meet the demand for its products or services, hire the employees it needs, secure office or retail space, and purchase necessary equipment.
Where to Find Financing
It’s recommended that you contact your local bank, credit union, or Community Development Financial Institution (CDFI) when seeking financing.
Community Development Financial Institution (CDFI)
A CDFI is a locally controlled private sector financial institution (sometimes funded by the Department of the Treasury) that focuses on personal lending and business development in low-income and urban communities, such as those in Indian Country, where citizens often lack access to traditional lending institutions.
Since the goal of a CDFI is to promote local economic growth, its lending practices are often less strict than other financial institutions.
Some CDFIs are certified by the Department of Treasury as “Native CDFIs,” which means that at least half of their activities are directed toward serving American Indians and Alaska Natives (AI/AN).
Preparing for Your Visit
When you arrange for a meeting with a loan officer at a lending institution, you should be prepared to show how a loan will benefit your business.
You should document your company’s profits during its time in business. If your business isn’t profitable yet, you’ll need to describe the steps you’re taking to achieve profitability.
If your business is a start-up, you should provide the officer with a business plan showing how your business will succeed.
You should also bring records documenting your personal and business credit history, tax returns from previous years, cash flow projections for the upcoming year, and relevant financial and bank statements.
Defining Common Finance Words
Principal is the amount of money you want to borrow that you will repay over an agreed upon period of time.
Interest is the amount of money you will pay the lender for borrowing its money over this period.
The interest rate is the amount charged, expressed as a percentage of the principal, by a lender to a borrower for the use of its funds. Interest rates are normally determined on an annual basis, and thus are listed with an annual percentage rate (APR).
Collateral are assets such as real estate, savings, equipment, or other items of value that the lender can use as a secondary source of repayment if the borrower is unable to repay the loan. Collateral reduces the lender’s risk of being unable to recover the money it lent to the borrower.
A secured loan involves collateral that the lender can recover in the event that your business doesn’t pay back its loan. Secured loans usually involve higher credit amounts (the amount of money the lender is willing to lend) and lower interest rates because they pose less risk to the lender.
Receivables financing describes a loan obtained based upon expected payments owed to you by a third party for your goods or services. This is a kind of short-term, secured loan.
A line of credit (also called “revolving credit” or “working capital”) is an account a lender makes available from which you can draw funds when needed, which provides flexibility. You can borrow money up to a pre-determined limit and must pay interest on the money you withdraw.
An equipment loan is used to fund the purchase of a particular vehicle, machine, or other device used for your business. These loans have fixed interest rates and terms.
Equity financing (also called “venture capital”) describes the sale of an ownership stake in shares of your business in return for an immediate cash. Keep in mind that it’s possible to sell so much of your company that you lose benefits that come with being a business that’s majority-owned by American Indians and Alaska Natives. For example, you could lose your eligibility to obtain an Indian Affairs Loan Guarantee (anchor link).
Loan Approval Process
Your lender will try to determine whether you have enough cash flow to pay back the loan in time and whether you’re a person that can be trusted to pay it back.
They’ll also attempt to figure out the collateral or security that they can receive if you don’t pay back the loan.
A private, Native-owned business may pledge land that it owns as collateral for a loan, but tribally owned businesses can’t pledge trust lands as collateral. However, some lenders have accepted leasehold mortgage interests as collateral, and others have taken equipment that a tribe has purchased through the loan.
In addition, the lender will want to know your credit score. A low score may disqualify you from a loan unless you can identify a source of collateral to secure the loan.
Another part of your business that the lender will review is your current debt and the diversification of your income streams. A lender may be less likely to offer a loan to you if your business is too dependent on one specific income source.
To further gauge your ability to pay, the lender may ask whether you’re contributing any of your personal funds to your business. They may express concerns if you’re depending only on financing to start or sustain your business.
From a legal standpoint, the lender will also check to make sure that there aren’t any liens against your business’s assets or lawsuits or tax liabilities that could threaten your company’s existence.
As a general rule, you’ll need to show that your business has been profitable over the past three years to obtain a bank loan.
When a lender deals with a private, AI/AN-owned business, it can seek to resolve contract disputes with the borrower through litigation, arbitration, or other means.
However, tribally owned businesses enjoy sovereign immunity.
These businesses must first grant their permission before any such dispute can be resolved in court, arbitration, or another venue. Indian Reorganization Act (IRA) Section 17 corporations and businesses created by tribal resolution have sovereign immunity.
To learn more about tribal business structures that preserve a tribe’s sovereign immunity, please see our “Choosing a Tribal Business Structure” page (link TBD).
On the other hand, if the tribal resolution establishing a business states that the business can sue and be sued, the business is likely a separate legal entity from the actual tribe and can’t claim sovereign immunity.
A tribal business may also waive its sovereign immunity.
This is called “a limited waiver of sovereign immunity,” and it’s a common feature of lending transactions involving tribally owned businesses.
Indian Loan Guarantee and Insurance Program (ILGP)
A federal loan guarantee isn’t a direct loan, but it’s still a promise by the federal government to pay back a certain percentage of a loan’s principal in the event the borrower defaults. This kind of guarantee reduces the risk to the lender and enables them to approve a loan that otherwise wouldn’t have been approved, or to offer a loan on better terms to the borrower (e.g., at a reduced interest rate or with a longer repayment term).
Through loan guarantees provided by ILGP, our Division of Capital Investment (DCI) helps tribes and tribal members overcome barriers to conventional financing and secure reasonable interest rates, while also reducing the risk to lenders by providing financial backing from the federal government.
In doing so, DCI is working to fulfill the mission of the Indian Financing Act of 1974 by reducing the disparity between the business capital available to tribal businesses and non-tribal businesses.
Washington, DC 20240