We help connect hundreds of borrowers with bankers every year, so we see a lot of potential transactions. There are common mistakes we see many SBA borrowers make, which are all easily avoidable. When applying for an SBA loan, borrowers need to be aware of common mistakes that can lead to their application being denied. Here are the most common mistakes we see:
1. Confusing cash flow with sales (aka revenues): Revenue is the total amount of money a business earns from its sales or services over a specific period. Revenue represents the top line of a business’s income statement and is often used to evaluate a company’s performance over time. Revenue is recognized when earned, even if the customer has not yet paid for the goods or services.
Sales or revenues are also referred to as “top line” as this number appears at the top of the income statement (aka profit and loss statement).
Cash flow is revenues less all expenses for any given period. Cash flow is the net increase or decrease in the cash balance during the period. There are various measures utilized to define cash flow – net income (aka the “bottom line), NOI, EBITDA, EBIT, free cash flow, etc. For most small businesses, cash flow is how much the bank balance increases or decreases. Note that debt payments are NOT included as part of the cash flow calculation.
Banks will want to see a business generate enough cash flow each month to allow the owners’ to make loan payments (aka debt service).
When banks how much your business is “making,” they are referring to cash flow not revenues. For example, a business with $1M in sales and $800K in expenses is making $200K per year, not $1M per year. In this example, at the end of the year, the business should have a $200K higher net bank balance that may be available for any loan payments. If a business generates sales of $1M and has cash expenses of $1M, there would be no cash available to cover the bank’s required monthly loan payments. As a result, the loan request would be surely denied.
2. Believing an SBA lender will lend 100% of the acquisition purchase price: SBA lenders require borrowers to have some “skin in the game.” The borrower typically must contribute 10% to 30% of the acquisition purchase price. The SBA requires a minimum of 10% and some banks will require 15% up to 30% down based a variety of deal specific factors, including but not limited to, the borrower’s industry experience, creditworthiness, industry, borrower’s credit score, and durability of the cash flow stream (i.e., how consistent the earnings have been over time. Many borrowers believe they can have the seller finance — the seller carrying a promissory note (loan) for part of the down payment. Banks
will not accept seller financing for the initial 10%. Banks may accept seller financing for a higher down payment for the portion of 10%, but they want the buyer to have skin in the game for at least 10%. And with seller financing, the seller will often have to subordinate — not get paid until after the bank is paid or after certain financial metrics have been met — which is often a deal breaker for many sellers. The only time the 10%+ down payment is ever waived is when the buyer already has an existing business that has equity on the balance sheet sufficient to cover the bank’s desired down payment, which we rarely see. The common exception is when a healthy business is buying the real estate the borrower is currently leasing.
3. Not reviewing financial/tax reports before applying for an SBA loan. Banks and other lenders will review a business’s financial statements or tax returns to assess its creditworthiness and determine if it is eligible for a loan. Lenders will look for evidence of consistent revenue, profitability, and cash flow to ensure the borrower can make timely payments on the loan. The very first questions a banker will ask a potential borrower will be centered around the financial condition of the business, so be sure to review with you accountant and/or financial advisor the financial statements (balance sheet and income statement) for the past three years. With the thousands of inquires we have received, we have never seen a borrower obtain a loan who answered “I don’t know what the cash flow numbers are.” If you don’t know, the bank won’t know, and you’ll be wasting each other’s time.
To avoid these and other common mistakes, at SBALenders.com we ask a variety of questions to help borrowers understand the specific data points bankers will ask. Simply complete the Find Me A Lender form, and we will be happy to assist so you can avoid the most common mistakes and make a great first impression.
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