Finding a small business loan isn’t for the faint of heart. You meet with bankers who throw around terms like basis points or variable rate and sometimes go through months of underwriting just to get declined based on a technicality.
If you’re getting frustrating loan declines, look into SBA financing. The Small Business Administration uses loan guarantees and other methods to make it easier for small businesses to get bank loans.
I worked on SBA loans in a sales and credit capacity for over five years. Let me share my best tips for getting a loan.
Overview: What is an SBA loan?
SBA loans are intended for borrowers who can’t qualify for a conventional loan. Often, borrowers who technically qualify for a conventional loan, but on terms far worse than SBA loan terms (e.g. 10-year term with a balloon payment or a variable interest rate), can use that excuse to get an SBA loan.
Commercial real estate (CRE) is the most common use of SBA loan proceeds, followed closely by working capital for operating expenses and business acquisitions.
What are the main types of SBA loans?
There are two main SBA loans, and they have predictably strange government names. The most common is called a 7(a) loan, the other is a 504 loan. Let’s go over both types.
1. 7(a) loans
7(a) loans are originated by banks or other lending institutions and are partially guaranteed by the SBA. The guarantee percent ranges from 75% to 85% based on the loan size. Almost every bank in the country is a Preferred Lending Partner (PLP) of the SBA which means they can approve and fund 7(a) loans in-house.
2. 504 loans
504 loans are actually two loans. A conventional note from a traditional bank for about half of the project costs and then a government-guaranteed loan with a Certified Development Company (CDC) for up to 40% of the rest of the project costs. CDCs are not-for-profit companies. The conventional loan is in first position regarding the collateral and would be paid off by the collateral before the CDC loan.
In both instances, the traditional bank originates the loan because it has protection, either in a direct loan guarantee or in excess collateral.
7(a) loan amounts can’t go over $5 million. 504 loans can be higher — it depends on how high the bank will go with the conventional loan.
4 loan requirements for getting an SBA loan
Here are the minimum requirements for an SBA loan. The requirements are generally the same, outside of business eligibility, as the PPP (Paycheck Protection Program) loan program.
1. Small business
The SBA wants to make sure it is not guaranteeing loans for big businesses. There is a two-part size standard.
If you do not pass this step, ask your banker about the secondary size standard. It’s based on shareholder’s equity, and you may still be able to make it work.
2. Eligible business
The SBA excludes certain business types because it is unseemly for the government to be involved with these businesses or because the business model can be considered gambling. Common business types excluded include:
- Non-profit: The loans are only available to for-profit businesses.
- Lending: Loan proceeds can’t be used for lending. A lending company may get an SBA loan for other purposes, such as purchasing real estate for an office.
- Gambling: This includes traditional gambling businesses, such as casinos, but also oil wildcatting.
- Prurient: No business that sells items related to sex can obtain a loan.
- Religious: No business focused on religion can get an SBA loan.
- Discriminatory: The obvious business model would be a club that excludes members of a certain race or religion, but a business like Curves (a gym that only allows female members) also can’t get an SBA loan. Businesses must prove they cater to all races, religions, sexes, etc.
- Marijuana: Any items federally illegal can’t be funded.
- Non-Owner Occupied: You can’t use SBA funds to purchase an investment property. You can lease part of a space if you occupy more than half of it.
3. Credit available elsewhere
Credit elsewhere was the bane of my existence as a lender. The bank must document why the loan would not be available conventionally — i.e., why it requires a government guaranty to be approved.
Often, the answer is simply that the borrower wants a 25-year term with a fixed rate, which is unheard of in conventional lending. The SBA is cracking down on these reasons and will usually want a few more. This is the bank’s responsibility to document so they may talk to you about it but you won’t need to stress out about coming up with reasons.
The SBA underwriting process is more forgiving than most conventional processes, but it could still trip you up. The SBA requires at least 1.25x debt service coverage ratio unless you’re using projected financials. With projections, you need to cash flow by year two.
The SBA also requires an analysis of the business, management team, industry/competitive position, and collateral. Real estate and equipment purchases face strict loan-to-value ratios and appraisal rules.
How to apply for an SBA loan
Here’s how your SBA loan application should go.
1. Get your documents together
You’ll be required to submit the following (among other bank-specific items):
- three years of business tax returns
- three years of personal tax returns
- a loan application that permits a personal credit report for all owners
- business debt schedule (BDS)
- personal financial statement (PFS)
- interim financials
- AR and AP aging reports
- entity documents
- purchase agreements
If you can organize all these items ahead of time, you’ll cut down the process dramatically. I spent most of my time as a banker following up on needs lists with borrowers. A warning: if you half-ass this process and just take a picture of the front page of your tax return with a cell phone or refuse to fill out the PFS, your banker won’t work hard on the loan. Why should they take the time if you won’t?
2. Meet with a business banker
It seems like every bank has different terms for business bankers. I’ve worked at banks that call them loan officers, business development officers, and business bankers. Some banks have catch-all bankers who will work with you on everything from credit cards to multi-million dollar real estate deals. Bigger banks will likely have specialists who work on only government-guaranteed loans.
Interview your banker and make sure they have plenty of experience with SBA loans. I would also tell them ahead of time to just be honest. Many bankers are worried about losing a deal and will exaggerate timelines or benchmarks. I’d rather know it would take eight weeks than think it will take four weeks and have it be six.
3. Go through underwriting
Underwriting can take two or three weeks. If it takes more than that, there’s probably something wrong. It’s possible the bank is slammed, especially if there’s a rate discount happening, but in normal circumstances underwriting shouldn’t take more than three weeks. As an underwriter, I processed 70 loans in one year which averages out to less than a week per loan.
On the other hand, be suspicious if your banker gets you into underwriting after only a week. Some bankers can pull this off, but getting appraisals ordered, working with the management team, and preparing a transmittal for the loan all take time.
3 tips for getting an SBA loan
Keep these things in mind when you apply.
1. Get your personal credit in line
The SBA does not allow loans to businesses where any owner has a FICO score under 670 or active derogatory, or late, accounts. Use your bank or credit card company to consider your credit report and be ready with an explanation for anything unusual.
2. Understand costs
The SBA charges 3.5% of the guaranteed portion of the loan for any 7(a) loans over $750,000. Additionally, the bank can charge a packaging fee of up to $2,500. Expect appraisal costs, appraisal review costs, titles fees, and environmental report fees. It will be hard to nail down the exact fees you’ll pay to get the loan, but be ready for it to be a large number.
3. Learn the SOP
The SBA standard operating procedures (SOP) are over 500 pages long. It’s unlikely you’ll be able to memorize them before you submit a loan. But having a handle on items such as who will need to guarantee the loan (all 20% owners), what the loan-to-value requirement is (90% on 504 loans), and what the permissible use of proceeds is will go a long way toward getting a loan done.
SBA loans can be more challenging to get done than conventional loans but they could be your last resort. Go into the process with the right expectations.
One more thing, banks don’t have as much room to work with you if your business goes downhill and you miss SBA payments. The SBA wants banks to get out of there and sell the collateral as quickly as possible. Be open and honest with your banker about your business so you can try to make it work any way possible if you need to.