The SBA recently released new procedural guidelines for SBA lenders for loans over $500,000. A review of what the SBA will ask from the SBA lender provides borrowers with key insights regarding SBA loan eligibility requirements. Documents SBA lenders must provide the SBA with each loan approval application:
SBA Lender’s Credit Analysis
The SBA lender’s credit memorandum and analysis addressing applicant’s ability and likelihood to repay the loan from the cash flow of the business. The SBA credit analysis report should include:
Business description – A description and history of the business, including nature of the business, length of time in business under current management, depth of management experience in the industry or a related industry, description of the business’s management team including principal’s involvement in the daily onsite management of the business or
Financial analysis of repayment ability – For existing businesses, three most recent years of historical financial information: federal business tax returns, balance sheets with debt schedule, and income statement, and interim monthly financial statements (balance sheets and income statements). For new businesses (including franchisee builds), detailed projections including financial assumptions which reflect positive cash flow within two We highly recommend borrowers seek assistance from finance professionals to generate financial statements and projections. The SBA lender’s financial analysis should address historical cash flow demonstrating total debt service coverage after the SBA loan.
If the historical and/or projected cash flow do not show sufficient debt service coverage, SBA lender must obtain two years of detailed projections and provide justification for using the projections instead of historical performance. Lender should provide a calculation of operating cash flow defined as earnings before interest, taxes, depreciation, and amortization (EBITDA); justification for additions and subtractions to cash flow such as unfunded capital expenditures, non-recurring income, expenses and distributions; distributions for S-Corp or partnership taxes, rent payments, and owner’s draw. Note that a buyer adding back an owner’s compensation to EBITDA is not warranted when the buyer will be taking a similar salary.
Debt Service (DS) analysis – Debt service is future required SBA loan payments (principal and interest) payments plus loan payments on all business debt. The potential borrower’s debt service coverage ratio (DSCR), which is EBITDA divided by /DS, must be equal to or greater than 1.15 on a historical and/or projected cash flow basis. For example, if a business generates EBITDA of $50,000 and has DS of $60,000, the business’s DSCR of .83 indicates the business does not generate enough cash to pay the $60,000 in annual loan payments. If the DS is $50,000, the business could make its loan payments if cash flow as measured by EBITDA is $50,000. However, the SBA and the SBA bank issuing the loan would want to see the borrower have some cushion in the financial forecast, thus a 1.15x ratio as opposed to 1x is required. For this example, for $50,000 in DS, the EBITDA would need to be $57,500 ($50,000 x 1.15). Some SBA lenders will ask for DSCR above 1.15 depending on a variety of factors.
For cash flow projections – The SBA lender must calculate DSCR and provide the assumptions supporting the projected cash flow coverage, including justification for revenue growth (i.e. new product lines, sales channels, and new production facilities), justification for any reduction in expenses, and a comparison to current industry standards.
Pro-forma balance sheet reflecting SBA loan and any other modifications to the assets or liabilities of a going forward basis, such as equity infusions, retirement of non-SBA debt, etc. Also, an analysis of working capital adequacy, at a minimum over the next 12 months. When 50 percent or more of the loan proceeds will be used for working capital, Lender must explain in its credit memorandum why this level of working capital is necessary and appropriate for the subject business.
Ratio calculations – SBA bank should provide current Ratio, Debt/Tangible Net Worth, Debt Service Coverage, and any other ratios the Lender considers significant for the business/industry (e.g., inventory turnover, receivables turnover, and payables turnover, etc.) including discussion of lender’s comparison to industry trends.
Collateral – Assessment of collateral adequacy to offset risk of default. Note that collateral is not required to be secured for loans under $50,000. For loans over $50,000 collateral is not required but must be secured if available. The SBA 7(a) lending program requires personal guarantees of all 20% or greater owners of the business.
Insurance – Insurance requirements include life insurance – on whom and how much in accordance with lender’s policies for similarly-sized, non-SBA guaranteed commercial loans, business hazard & liability insurances, and other insurances, such as specialty insurance appropriate for the type of business, e.g. malpractice insurance or product liability insurance.
Debt refinancing – Lender must document the refinancing of any debts as part of the loan request in accordance with the policies and procedures the Lender uses for its similarly-sized non-SBA guaranteed commercial loans. Note that a borrower can not retire an existing SBA loan with proceeds from a new SBA loan.
Business valuation – For a change of ownership, discussion/analysis of the business valuation used to support the purchase price.
Approval rationale – Bank’s rationale for recommending approval, including a discussion of competition, seller financing, stand-by agreements, 90+ day delinquencies, trade disputes, government citations which would preclude the borrower from normal business operations, discussion of any liens, judgments, bankruptcy filings or pending litigation including divorce proceedings, and a discussion of other relevant information.
Down payment – Lender’s requirement for equity and equity injection must be consistent with its requirements for similarly-sized, non-SBA guaranteed commercial loans except for the SBA minimum equity injection requirements below. Borrowers should note that SBA lenders internal underwriting standards may require more equity than the SBA’s minimums.
At a minimum, SBA requires an equity injection of at least 10 percent of the total project costs. Some SBA banks will require a larger down payment than the SBA minimum, typically 15% – 20% depending on the facts and circumstances of the borrower and the business. Seller debt may not be considered as part of the buyer’s down payment unless either the debt is on full standby – no interest or principal payments – for the first 24 months of the 7(a) loan or the debt is on partial standby – interest payments only – when there is historical business cash flow available to make the SBA loan payments
Equity injection (aka the buyer’s “down payment”) is new cash or other acceptable assets added that is not on the applicant’s balance sheet prior to the equity injection. When an existing business acquires a business that is in the same 6 digit NAICS code with identical ownership and in the same geographic area as the acquiring entity, SBA considers this to be a business expansion, and SBA will not require a minimum equity injection.
For partial changes of ownership where the buyer isn’t acquiring 100% of the business, the business balance sheets for the most recent completed fiscal year and current quarter must reflect a debt-to-worth ratio of no greater than 9:1 prior to the change in ownership. If the ratio of debt-to-worth ratio is greater than 9:1, the lender, the borrower(s) must contribute cash in the amount of at least 10% of the partial change of ownership purchase price. Borrowers should note that SBA-financed partial ownership changes were not allowed before May 11, 2023.