When applying for a Small Business Administration (SBA) loan, one of the crucial requirements is demonstrating the inability to obtain credit elsewhere. This condition, mandated by the Small Business Act enacted by Congress, applies to both SBA 7(a) and SBA 504 loans. In this article, we explore the significance of this requirement and discuss common reasons why applicants may not be able to find credit elsewhere.
The “No Credit Available Elsewhere” Clause
The Small Business Act clearly states that no financial assistance shall be granted under the SBA program if the applicant can obtain credit from other sources. This provision ensures that the SBA loan program primarily benefits small businesses that genuinely need financial support and are unable to secure loans through traditional means.
Impact of Changes Starting 8/1/23
Beginning August 1, 2023, the SBA no longer requires SBA lenders to consider the personal resources of the owners when evaluating credit availability elsewhere. This change eliminates a significant barrier that previously hindered “wealthier” borrowers from obtaining SBA loans. Previously, their personal assets were considered, leading lenders to conclude that the applicant could easily secure financing independently.
Common Reasons Applicants Cannot Find Credit Elsewhere
Longer Loan Amortization Period
SBA loans typically offer extended repayment terms of 10 to 25 years, while conventional loans often have shorter terms of 5 to 7 years. Businesses requiring longer amortization periods due to cash flow constraints may qualify under the credit unavailability clause.
Insufficient Collateral
Many conventional loans require full collateralization, meaning the value of collateral must equal or exceed the loan amount. SBA applicants often lack sufficient collateral, making it difficult to obtain loans through traditional avenues. Insufficient collateral is often the base when a borrow is looking to buy a business. As a result, the vast majority of SBA 7a loan requests are business acquisitions.
Credit History
Both business and personal credit history play a vital role in loan approval. Applicants with inadequate credit records may find it challenging to secure credit elsewhere. Many borrowers believe their credit history does not matter since the SBA is guaranteeing the loan for the SBA lender. This is not the case. Most SBA lenders in our network require a borrower’s credit score to be 680 or higher.
Management Experience
Lenders often consider the management team’s experience when evaluating loan applications. Lack of sufficient management expertise may limit access to conventional credit.
Leverage Ratio and Equity
Conventional lenders generally assess the borrower’s leverage ratio and require a significant equity stake. SBA loans may provide an alternative for businesses with limited equity or higher leverage.
Global Cash Flow
The applicant’s global cash flow, including that of affiliated entities, is another factor that lenders consider. If the overall cash flow does not meet conventional loan requirements, the SBA loan option may be more viable.
Loan Size and Business Age
Conventional lenders may have restrictions on loan sizes based on the age of the business. SBA loans can be more accommodating for newer businesses requiring larger loan amounts. For example, many SBA lenders will lend against projections for a franchise startup, but few conventional lenders will.
Documenting “Lack of Credit Elsewhere”
To expedite the loan processing, the SBA encourages lenders to use automated processes for documenting the lack of credit elsewhere. This typically involves checking a box from a predefined list of acceptable factors that demonstrate the applicant’s inability to secure credit elsewhere. As long as an acceptable factor is checked, there is no additional SBA requirement for a written justification.
Final thoughts
The SBA requirement of credit unavailability elsewhere is an essential criterion for obtaining an SBA loan. Understanding the common reasons why applicants may not find credit elsewhere and how lenders document this lack of credit availability can assist businesses in navigating the loan application process. By meeting the SBA’s credit eligibility criteria, small businesses can access the financial support they need to grow and thrive.