What are the qualifications for an SBA Loan?
A Borrower (Business Owner) which wants to obtain an SBA Loan needs to have a working knowledge of these qualifications:
1. BORROWER
While there are many factors affecting the ability for a person to be eligible as a borrower, the question remains who can be a Borrower for an SBA Loan?
The first test is ownership of a business. Do you work for yourself or do you share ownership of a company which is a legal entity (Corp, LLC, and Trust)?
If you have 100% ownership interest in a business, then the answer is easy. However, if the business is a legal entity, then anyone who owns 20% or more of this legal entity will have to be a Borrower and guarantee the loan. People with less than a twenty percent ownership interest do not usually have to be a Borrower and do not have to be a Guarantor.
If a person owns a business with more than one person, one of these owners needs to be designated as the representative of the company who has the authority to apply for the SBA Loan. This can be accomplished from the designated job position of a person (President, CEO, Managing Member, Trustee) or from a written document signed by all owners of the company.
A Borrower will have to “guarantee” repayment of the loan. In other words, if there is a payment default, a Borrower himself agrees to pay back the Lender in full. Usually, if a Borrower owns real estate or another kind of personal asset which can have a lien placed on it, the Lender will require the Borrower to allow the Lender to place a lien on this asset in case of loan default. The Lender will then be able to take the asset and sell it to be paid back.
The planning for the preservation of assets in case of loan default is an important part of being in business and for anyone contemplating being a Borrower.
2. CASH REQUIRED
The funds needed for the down payment plus any upfront costs required during the processing and underwriting of the loan is the required cash. An SBA Lender calls this required cash, “the Borrower’s cash injection.”
Another portion of the cash required is any processing fee or underwriting fee and “third party costs” needed to complete the underwriting of the loan. The third party costs may include a business appraisal or real estate appraisal, construction supervisor fees, environmental report fee, legal research fee, etc.
These are known as “upfront costs”. There is no set industry standard for when these upfront costs are paid. They may be due any time from when a “Letter of Interest” is provided to after the Commitment Letter issued.
Borrowers must have the cash needed for the transaction in a bank account for three months
prior to closing. If the Borrower does not have all the cash, the Borrower can qualify with a
gift from another source. On a case-by-case basis, borrowing the funds from investment
property or another source may qualify the Borrower.
3. CREDIT
Many lenders have hard credit score requirements. If a borrower does not have scores over a certain set number, the lender will not entertain the loan application. This is not an SBA requirement, but an “overlay” which the lender has included as part of its underwriting criteria.
There are national SBA Lenders who do not have a minimum credit score requirement. These lenders will look past a credit score to find out the “story” of the Borrower’s credit history. However, a Borrower will have major hurdles to overcome or not be able to qualify if there are issues on a credit report: late payments, charge offs, judgments, tax liens and the like.
A Borrower should have ready a “Letter of Explanation” for any credit issue in the borrower’s history.
4. CRIMINAL RECORD
Felons are not qualified. It does not matter how long ago the conviction occurred. When a background check finds a felony conviction, the applicant is not eligible for an SBA Loan. Misdemeanors are on a case-by-case basis as reviewed by an underwriter.
5. EXPERIENCE
Borrowers must have at least one year of experience as an owner or manager in the industry of the business. A resume may be required to prove this experience.
Experience in a different industry can sometimes be transferred on a case-by-case basis. But, just because you were the president of a landscaping company does not mean you are qualified to apply for a loan to own a restaurant.
Education is never itself qualification for the experience required to qualify for a loan. Bringing in a Co-Borrower with the required experience is an option. See Co-Borrower.
6. FOREIGN NATIONAL
Borrowers need to be citizens of the United States or have a green card.
If a Foreign National wishes to be part of a transaction where an SBA Loan will be the lending source, the Foreign National must “partner up” with a United States citizen or one with a green card. In this situation, the Foreign National must have a minority ownership interest for the loan to pass this criteria.
7. INCOME
An SBA Lender wants to make sure the borrower has enough household income to cover the borrower’s household expenses including food.
The industry standard for a borrower’s household income contribution is thirty thousand
($30,000) dollars. There are always exceptions on a case-by-case basis. A “Letter of Explanation” must be provided by the Borrower which describes how the household is paying its expenses.
8. MANAGEMENT
On a case-by-case basis, a management company instead of hands on supervision of the business may be acceptable.
An alternative is to hire a W-2 Employee to manage the business. This Employee must prove competence with a resume.
These options are important where the borrower does not live near the business or owns multiple businesses.
9. NET WORTH
The Definition of Net Worth is “The Value of All Assets Minus the Liabilities of an Individual”.
A borrower must show on a Personal Financial Statement the funds required for a down payment (Cash Injection) and the funds required for the costs of the Loan (Appraisal, Environmental Report, Legal Research, etc.).
The Lender may also require additional collateral to qualify the Borrower for a loan. This is why it is vital to show all assets owned on a Personal Financial Statement. Assets owned by a Borrower may include real estate, stocks, bonds, certificate of deposit or whole life insurance with cash value, to name a few.
Ownership of other businesses is also an important asset. The net income from another business can be used as part of the overall cash flow available to pay for the new loan.
10. OWNERSHIP
Any person who owns 20% or more of a business or will own 20% or more of a business being acquired must be a Borrower and Guarantor. Conversely, any person who has less than a 20% ownership interest will usually not be Co-Borrower and Guarantor (even if bringing in cash to the transaction).
11. PROPERTY TYPE & BUSINESS TYPE
A. There are no SBA Regulations which prohibit a particular type of property (real estate or non-real estate) from being eligible as collateral for an SBA Loan.
B. However, SBA Regulations as found on the SBA Website does list certain types of businesses which are not eligible:
i. Real estate investment firms when the loan is used for investment purposes.
Comment – SBA Loan will not fund the purchase of investment real estate.
ii. Firms involved in speculative activities that develop profits from fluctuations in price rather than through the normal course of trade, such as wildcatting for oil and dealing in commodities futures, when not part of the regular activities of the business.
Comment – SBA Loan will not fund a business which makes its money by being involved with “Rolling The Dice” transactions.
iii. Dealers of rare coins and stamps
Comment – SBA considers this a speculative activity.
iv. Firms involved in lending activities, such as banks, finance companies, factors, leasing companies, insurance companies, and any other firm whose stock in trade is money.
Comment – An SBA Loan cannot finance companies that make their money by using money to earn income.
v. Pyramid sales plans, where a participant’s primary incentive is based on the sales made by an ever-increasing number of participants.
Comment – The SBA wants a company to produce something for the economy. An AMWAY Network Dealership is a good example of this ineligible business type.
vi. Firms involved in illegal activities.
Comment – Federal law still prohibits marijuana sales
vii. Gambling activities including any business whose principal activity is gambling. The rule does not restrict loans to businesses that obtain less than one-third of their annual gross income from either the sale of official state lottery tickets under a state license, or legal gambling activities licensed and supervised by a state authority.
Comment – Most SBA Lenders will not allow more than 30 – 49% of all income be from gambling. In addition, SBA Lenders will not finance businesses which have exotic dancers unless these dancers are fully clothed.
viii. Charitable, religious, or other nonprofit institutions, government-owned corporations, consumer and marketing cooperatives, and churches and organizations promoting religious objectives.
Comment – SBA Lenders will only finance “for profit” companies.
Joel Soforenko is an industry veteran having extensive experience with SBA 7(a), SBA 504 and USDA loans. He has assisted borrowers as a loan originator, processor, underwriter and Manager of the SBA Department of a major origination platform.
Joel is now the CEO of Continental Finance Capital Corp and can be reached at (617) 336-3215 x 5 or joel@continental.finance.