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What Is An SBA Loan?

An SBA loan is a small business loan made by a private sector lender (such as a local bank or other lender) that is in turn guaranteed by the United States Small Business Administration (“SBA”) pursuant to the terms of the U.S. Small Business Act, as amended (“Act”).  Though sometimes challenging because of the SBA’s additional regulatory requirements, when handled by a knowledgeable lender and counsel, an SBA loan is very user friendly and provides a financing mechanism which all businesses should at least consider.  In fact, most businesses find lenders more receptive to making a loan when the borrower requests an SBA loan. 

What Types Of SBA Loans Are Available?

Most SBA loans fall under two categories:  7(a) and 504.

  • In an SBA 7(a) transaction, a loan is secured from a private sector lender and, provided that the lender and borrower have complied with the requirements of the SBA, if the borrower defaults on the loan, the SBA will reimburse the lender for a percentage on the loan loss (usually 75% or 85%, depending on various factors). 
  • In an SBA 504 transaction, all concurrently:  a loan is secured from a private sector lender with a first position lien covering up to 50% of the project cost, and a second loan is secured from a private sector lender with a junior lien position covering up to 40% of the project cost, and the borrower makes a contribution of equity equal to at least 10% of the project cost.  After the closing of the first and second loans, and provided that the lender and borrower have complied with the requirements of the SBA, a debenture is sold to investors, the proceeds of which pays off the second loan, whereupon the second loan is assigned to a Certified Development Company (“CDC”) and then to the SBA, which provides a 100% guarantee of the debenture.
  • The existence of the SBA’s guarantee is each of these transactions is an inducement for the lender to make a loan on terms it would otherwise not make.  However, the SBA guarantee does not allow the lender to disregard standard commercial underwriting principles such as collateral and personal guarantees. The SBA guarantee does allow the lender to loan more money, extend longer terms, and approve loans to less mature businesses than it otherwise would.
  • The SBA’s purpose under these financing programs is to help businesses gain more access to capital, thereby creating jobs and expanding the tax base. Pursuant to the Small Business Jobs Act of 2010 (“2010 Act”), the maximum SBA guarantee to the lender on a 7(a) loan was increased to $5,000,000; and on a 504 Loan, the maximium debenture amount was increased to $5,000,000.

Where Can I Get An SBA Loan?

National and community banks and other commercial lending firms often offer SBA loans as part of their lending products.  Some lenders do considerable SBA lending and, therefore, have made the commitment of people and departments dedicated solely to SBA lending, whereas other lenders “dabble” in SBA lending, in which case the lender’s loan officer may not be as experienced with SBA lending products and policies.  There are basically three types of SBA lenders: a preferred lender is one that can make some loan decisions without the SBA’s approval; a certified lender gets priority processing from the SBA; and a general lender is one that is licensed with commercial lending experience.  Some lenders only make 7(a) loans or 504 loans, while other lender offer both of those loans and other SBA loan products.  Also, for 504 loans, the CDC is an indispensable party which is involved in the closing, funding and servicing of the 504 loan.  A CDC is a private, nonprofit corporation which is set up to contribute to economic development within its community. CDC’s work with the SBA and private sector lenders to provide financing to small businesses, which accomplishes the goal of community economic development and creating jobs.  Each state has one or several CDC’s.

What Are Some Features of SBA Loans?

  • Some Basic SBA Loan Features.  Commercial mortgage loans for the purchase, new construction or refinance of commercial properties account for the largest volume of SBA loans. The property must be “owner occupied,” which means that the borrowing entity (or the business) must occupy at least 51% of the space if it is an existing facility or 60% if it is new construction.   While the business must lease the entire property, the balance of the space can be subleased to third parties.  The SBA loan program is very popular for several reasons, including: (1) the loan amortization can be up to 25 years with no balloon provisions, as is customary with conventional loans; (2) the amount financed can be as much as ninety percent and occasionally higher (versus seventy to seventy-five percent on a conventional basis); and (3) the loan can be assumed by an SBA-eligible borrower.
  • Eligible Businesses.   The Act defines an eligible small business as one that is independently owned and operated and not dominant in its field of operation. The Act also states that in determining what is a small business, the definition shall vary from industry to industry to adequately reflect industry differences.  The SBA has developed size standards that define the maximum size of an eligible business and most businesses are considered small.  However, these represent general definitions and in some cases are further defined by a specific sic code.  Under the 2010 Act, the law was expanded so that the number of small businesses eligible for SBA loans was increased.  When affiliations exist with other companies (for example through common ownership, directorships or by contractual arrangements), the primary business activity must be determined both for the applicant business as well as for the entire affiliated group.  In order to be eligible for financial consideration, the applicant must meet the size standard for its primary business activity and the affiliated group must meet the standard for its primary business activity.  Check with a experienced SBA lender to see if your business is eligible.
  • How SBA Loan Funds May Be Used.  For 7(a) Loans, loan proceeds may be used for working capital; to purchase a land or building; for construction; to purchase equipment, machinery, furniture, supplies, and materials; to establish a new business or to purchase an existing business.   For 504 Loans, loan proceeds may be used to purchase a land and buildings; for construction of improvements to land; to purchase long-term equipment and  machinery, and, in some cases with very specific circumstances, to refinance existing debt. The 504 program cannot be used for working capital or inventory, consolidating or repaying debt or refinancing.
  • SBA Loan Maturities.  SBA loan programs are generally intended to encourage longer term small business financing but actual loan maturities are based on the ability to repay, the purpose of the loan proceeds, and the useful life of the assets financed. For 7(a) loans, maximum loan maturities have been established: 25 years for real estate and equipment; and generally, 7 years for working capital.  For 504 Loans, maturities of 10 and 20 years are available.
  • Interest Rates Applicable To SBA Loans.  Interest rates are negotiated between the borrower and the lender but are subject to SBA maximums, which, for 7(a) loans, are pegged to the prime rate or to LIBOR.  Interest rates may be fixed or variable. Interest rates on 504 loans are pegged to an increment above the current market rates for five year and ten year U.S. Treasury issues. Check with your lender to determine current rates on its SBA loans. 
  • Other Important SBA Loan Terms and Criteria.  Repayment ability from the cash flow to business is a primary consideration in the SBA loan decision process but good character, management capability, collateral, and owner’s equity contributions are also important considerations. In 7(a) loans, all owners of twenty percent (20%) or more of the Borrowing entity are required to personally guarantee the loan.  For 504 loans, personal guarantees of the principal owners are also required.  504 loans cannot be made to businesses engaged in speculation or investment or rental real estate.  There are often prepayment penalties with SBA loans; however, as the terms of each loan are specific to the facts regarding that loan and the borrower, make sure to check with the lender regarding any prepayment penalties. Loans to the borrower from its owners or from third parties must be made subordinate to the lien of the SBA loan and are often required to be on “standby” during the existence of the SBA loan.

How Should The Business And Borrower Be Structured For An SBA Loan?

While the choice of the form of the entity of borrower and the structure of the business are personal to the business’ owners – and often this decision is driven by important tax and relationship factors – there are commonly entity and structure requirements of the SBA that must be satisfied regarding the SBA loan being considered.  Accordingly, it is very important to check as early as possible with the lender and with borrower’s legal counsel (and accountant) regarding the choice of entity for borrower and the structure of the business.