What you need to know about Small Business Administration (SBA) Loans

The SBA is a federal program under the auspices of the Executive Branch of the Federal Government. The Commissioner of the SBA is a member of the President’s Cabinet. One of its primary purposes is to provide resources to the small business community in order to enhance economic growth.

In this regard, it serves a guarantor to loans offered by commercial lending institutions who have authority by the SBA to grant such loans. The SBA is not the entity that actually makes the loans, rather it will back up (to a certain point) the risk associated with a loan. Say a business needs to borrow $100,000.00 in order to start up a business. First, a strong and viable business plan and cash flow projections will be needed. Often emerging entrepreneurs will work with an SBDC in order to obtain these needed documents.

The entrepreneur will then go to a bank, who first will lend to a startup business and second, who is recognized by the SBA as a lender knowledgeable enough in the SBA process. If the lender understands the business plan and related cash flow projections to be accurate and viable, the loan process will begin.

Depending on the robustness of both the business plan and cash flow projections, the SBA can guarantee any where from 10 to 90 percent of the loan. This means that should the borrower default on the loan, the SBA will be liable for whatever percentage they agreed to claim with the actual lender being at risk for the remainder. The lender sees this as a great advantage in that assuming full risk for default, especially as it relates to a startup business, that is too risky to commit without the support (guarantee) from the SBA.

In addition to the provision of a sound business plan and cash flow projections, there are numerous other requirements that have to be met. Credit worthiness and score are key criteria. While the lender makes the decision on the credit, the average minimum score is 650. While certain lenders may consider a slightly lower score, much is dependent on the strength of the business and cash flow projections.

A personal Financial Statement (PFS) will also be a requirement. This document displays all of the assets and liabilities of the borrower. In essence, how much money do you have in cash, bonds, real estate, stock, W-2 employment, etc. against debt and expenses. The first minus the second determines your net worth, which is a critical component to the lenders ability to lend. Also, what you have in assets will need to be put up as collateral against what is being borrowed. As an example, if you own property houses, including your personal residence, all of this will have to be collateralized.  Often the borrower has issues with this aspect of the requirement. Thus, the need to know upfront.

Another requirement is equity. This means the amount of liquidity you are willing to put into the business. This can come from cash, stocks, bonds, and anything that can easily convert to cash. Often borrowers believe the lender is going to loan the full amount of the ask. No, lenders want the borrower to assume some risk. The lender will never lend the full amount. Typically, this requirement is between 10 and 20 percent of what is being borrowed. As an example, if the borrower wants to borrow $100,000.00, she/he will have to come up with anywhere between $10,000.00 and $20,000.00 before the lender will release the remaining portion of the loan.

Typically, the lender will first want the borrower to use and spend down the equity portion first before any advance on the loan will be made to the borrower. One might ask why? The reason being the lender wants the borrower to also take risk in essence to have “skin in the game”! There will never be a loan made to a startup business without owner equity being required.

Another requirement is often referred to as the “51 percent rule”. The borrower/owner of the business must have her/his business occupying at least 51 percent of the space that is being used for the business if build out and/or rental expenses can be included as legitimate expenses for purpose of qualifying under the terms of the loan. Again, at least 51 percent of the space must be used for purposes of the business. Along these lines, let’s say you are only going to use 25 percent of the space for your business and the reminder you are going to rent out, you would not be able to claim or use the space as part of the loan in that these associated expenses could not be included.

As an SBA guaranteed loan thru the lender, the borrower may not have any outstanding issues with the federal government. As examples, any government loan, such as student loans that are in default, disqualifies the borrower from obtaining any SBA guaranteed loan. Criminal or other activities defined by the federal government as being unlawful are also immediate disqualifiers.

Remember the SBA is not the lender. The lender is a bank or other lending institution that is capable of lending money on behalf of the SBA. The SBA serves as a guarantor on a portion of what is being borrowed, such that the lender is not assuming all of the risk associated with what is being borrowed this making it attractive for startup businesses.

For growth, businesses i.e., those already in business, assuming they have strong business financial statements demonstrating growth or the strong potential to grow, certain accommodations may be considered. In such case, an abbreviated business plan/overview along with the financial statements might suffice for qualifying for an SBA guaranteed loan also remember regardless of the situation the borrower will have to also provide three years of tax returns.