Editorial · January 18, 2019
SBA 7(a) Loan Requirements: What Lenders Check
SBA 7(a) loan requirements come down to three questions: is your business eligible, can it repay the loan, and can you show it on paper. The 7(a) loan is the main loan the U.S. Small Business Administration guarantees. A bank or other lender makes the loan, and the SBA backs part of it. That backing lets lenders say yes to some owners they might otherwise turn down.
This guide explains what lenders check, in the order most of them check it. It gives a broad overview only. For advice on your own loan, talk to a lender, a lawyer or an accountant, and ask the lender for current terms before you apply.
Is your business eligible?
The federal rules set five basic tests. Your business must be an operating business, organized for profit, and located in the United States. It must be small under the SBA size rules. And it must be able to show a need for the credit.
Some businesses cannot get a 7(a) loan at all. The list includes non-profits, businesses that mainly lend money, passive landlords who do not use the property themselves, and businesses that make more than one third of their revenue from legal gambling. Pyramid sales plans, private clubs, government-owned entities and speculative businesses such as oil wildcatting are also out. So is any business with an owner who is incarcerated, on probation or parole, or under felony indictment. A business that earlier defaulted on a federal loan and cost the government money is out too, unless the SBA waives the rule for good cause.
What can you use the money for?
The loan must serve a sound business purpose. Allowed uses include buying land or a building, building or renovating space, buying equipment, and paying for inventory, supplies and working capital. A 7(a) loan can also help you start a business or buy one.
Some uses are off limits. You cannot use the money to pay yourself or other owners beyond normal pay for work done. You cannot use it to pay past-due payroll or sales taxes that you owe to a government. You cannot use it to buy only a part of a business, though buying an entire business, or an owner buying out another owner completely, is allowed. You also cannot use it to pay a lender that could lose money on an old debt, so the SBA does not take over that risk.
What do lenders check about credit?
The rule says the borrower must be creditworthy and the loan must be sound enough to reasonably assure repayment. Lenders look at nine things. They are the character and credit history of the owners and guarantors, management experience, the strength of the business, past earnings and projected cash flow, ability to repay from business earnings, enough invested equity, long-term prospects, the value of collateral, and the effect of any affiliates.
Weak collateral alone is not supposed to sink an application. The SBA tells lenders that many borrowers use the program because they can repay but lack enough assets. Still, a lender will want to see that the business earns enough to cover its debt. For smaller loans, the SBA asks the lender to show that income is at least equal to the yearly loan payments, a ratio of 1 to 1.
What forms and records will you need?
Expect to fill out SBA Form 1919, the borrower information form. It asks about you, the business, any debt, your owners and affiliates, and your history with government financing. If you report certain criminal history, you also need Form 912. Every owner of 20 percent or more, and every guarantor, completes a personal financial statement such as Form 413, dated within 90 days of the application.
Lenders also ask for business financial statements or tax returns dated within 180 days. These usually include year-end balance sheets and profit and loss statements for the last three years, plus current interim figures. Lenders also send IRS Form 4506-T so they can check your tax figures against IRS records. A copy of your lease may be needed if you rent your space. If you paid a packager, broker or lawyer to help prepare the application, Form 159 discloses that fee.
How big can the loan be, and for how long?
The largest 7(a) loan is $5 million. Congress raised the cap from $2 million in the Small Business Jobs Act of 2010. The SBA guarantees up to 85 percent of loans of $150,000 or less and up to 75 percent of larger loans. The guarantee protects the lender, not you. You still owe the full debt.
The shortest term that fits your ability to repay is the rule. The most a loan can run is 10 years, unless it pays for real estate or equipment with a longer useful life. Then it can run up to 25 years. Lenders may charge a reasonable fixed rate or, with SBA approval, a variable one, and the SBA sets maximum rates. In October 2018 the top fixed rate for a loan over $50,000 with a term of seven years or more was 11.13 percent. A variable rate may be tied to the prime rate, which was 5.25 percent that month.
What about collateral and personal guarantees?
For a loan of $25,000 or less, the SBA does not require the lender to take collateral. For loans above that and up to $350,000, the lender must at least take a first lien on what the loan buys and liens on the business fixed assets until the loan is fully secured. For loans above $350,000, the lender must secure the loan as fully as it can. If business assets fall short, the lender must also take available equity in the owner's personal real estate.
Owners of 20 percent or more of the business generally must sign a personal guarantee. That means you promise to repay if the business cannot. The SBA may also ask for guarantees from others, and may ask a seller who stays on as an owner to guarantee the loan.
A few last tips. Gather your tax returns and statements before you call a lender. Check your own credit history for errors. Write a short plan that shows how the loan will be repaid. Congress changed some 7(a) oversight rules in 2018, including how the "credit elsewhere" test is defined, so ask your lender how it applies that test today.