NINE MONTHS AFTER bailing out insurance giant American International Group (AIG), the government launched in June its big program to help small businesses ride out the economic storm, but many businesses say the move came too little and is too complicated to be effective.

Under the America’s Recovery Capital (ARC) Loan Program, the Small Business Administration earmarked $255 million to fully guarantee 10,000 loans of up to $35,000 to help struggling small businesses pay down their debts. The ARC loans promise grand inducements like a 100% SBA guarantee, zero interest, a five-year repayment period, no fees and 12 months of deferred payments, but small-business owners and advocacy groups say the qualifications for the loan are so strict and complex that they undermine the program.

“We had a bank loan meeting on Friday, and when the ARC loan came up, everybody laughed,” says Dave Mulcahy, the director of the Small Business Development Center at Lamar University in Beaumont, Texas. “There are a lot of hoops to jump through and we aren’t getting anything accomplished,” he says.

Mulcahy has plenty of company. Although 1,852 small-business owners had secured an ARC loan as of Monday, those who didn’t make the cut (or who were deterred from applying by the stiff requirements) are growing increasingly perturbed by the program. Small business counselors and consultants across the country have also voiced concern. And U.S. Sen. Bill Nelson (D., Fla.) decried ARC loans in a letter he wrote to President Barack Obama last week.

In the letter, Nelson writes that many of the banks refusing to issue ARC loans have received billions in federal bailout money. In particular, he says that Bank of America (BAC) and Citigroup (C) — two of the largest beneficiaries of the Troubled Asset Relief Program (TARP) — have reduced their SBA lending by more than 85% during the first seven months of their 2009 fiscal years.

Even the SBA’s own preferred lenders are largely shunning the program. Of the SBA’s 637 preferred lenders, just 20% have issued ARC loans, according to the SBA. And the majority of the loans granted so far have come from the Midwest, while entrepreneur-rich states like California and New York have managed to lasso just 31 and 28 loans, respectively.

So what’s the problem?

The ARC loan application requirements are targeted at a particular subset of small businesses in trouble. Applicants must demonstrate an immediate financial hardship, such as a 20% decline in sales, revenues or working capital, but they also have to be “viable.” In other words, the SBA wants to help established firms that aren’t about to file for bankruptcy protection. To prove their viability, small businesses must show evidence of profitability or positive cash flow in at least one of the last two years, two years of reasonable cash flow projections and an acceptable credit score. Also, they can’t be any more than 60 days past due on any loan being paid with an ARC loan.

In addition, “most businesses can’t meet the ARC loan program’s documentation requirements,” says Tom Burke, the senior vice president of Wells Fargo (WFC) SBA lending in Minneapolis. The requirements include showing old receipts for business-related activities that created the debt to be paid off by the loan.

Moreover, meeting ARC Loan program standards for viability in a weak economy has been problematic, says Ann Kayman, the chief executive of New York Grant Company, a small business funding consultancy in New York. “It’s fairly rare to find a [small] business that was operating in the black in the past couple years,” she says.

Mark Truman, the executive director of Omniac Education, a tutoring service in Albuquerque, N.M., was turned down for an ARC loan because of dismal profits in 2008. “It seems like the [qualification] for getting the SBA loan is not needing one,” he says. “It’s not about my business. It’s not about Wells Fargo. It’s about a poorly designed program.”

Although the SBA attempted to clarify the program by issuing new guidance this week, business owners and lenders remain confused by the program, Mulcahy says. “What the stimulus package did was put in too many controls and not enough money for the bankers to get in,” he says. And given that the ARC Loan program is temporary, a number of banks consider the incentives for administering the program to be insignificant, Mulcahy says.

Still, the SBA is making progress. With approved ARC loans totaling more than $60.1 million, or roughly a quarter of the allotted amount dedicated by the government, “we’re encouraged,” says Jonathan Swain, an SBA spokesman. “We expect that the program will be fully utilized before the statutory deadline of Sept. 30, 2010.”

-Writeto Diana Ransom at dransom@smartmoney.com

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