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SBA Loan Guarantees

Filed under Getting Financing. Fact checked on May 24, 2012.

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To encourage private lenders to provide funding to small businesses, the SBA will guarantee repayment of a substantial percentage of the loan amount if the borrower defaults on the loan. Find out your options, what business qualify, and which businesses aren't eligible for SBA-backed loans.

To help small business receive funding they need to open and operate, the SBA offers private lenders a guarantee on loans made to qualified small businesses. 

Understanding Loan Guarantees

Like any loan guarantee, if you, the borrower, fail to pay the loan, the lender can usually obtain up to 85 percent of the outstanding loan principal from the SBA.

The government guarantees encourage lenders to grant credit that otherwise would not be available on reasonable terms and conditions.

Commercial lenders often prefer a SBA-guaranteed small businesses loan because the federal guarantee:

  • reduces the lender's risks
  • creates a readily available secondary market in which to sell the guaranteed portion of the loan
  • does not count against the federally mandated reserve funds that banks must maintain as protection against loan losses.

How SBA-Guaranteed Loans Work

Most often, entrepreneurs seek an SBA guarantee when a conventional lender feels that the prospective borrower has insufficient collateral to support the small business loan request. The SBA loan guarantee works as a substitute for the needed collateral and provides the lender with satisfactory security to support the loan. If the borrower fails to repay the loan, the lender can recover the guaranteed portion of the loan from the SBA.

Understanding a Limited Guarantee

As of  June 2012, the maximum loan amount for a 7(a) loan guarantee is $5 million, and the maximum amount guaranteed by the SBA is $3.75 million. Small loans (those under $150,000) carry a maximum guarantee of 85 percent. Loans greater than $150,000 are guaranteed at 75 percent.

Obtaining an SBA loan guarantee will require a bit of legwork on your end.  

Achieving the Required Owner's Equity

The SBA prefers an owner's equity investment of at least 25 percent of the total cost of the project. While no fixed legal requirement actually exists, the SBA (and the lender) want proof that you won't walk away from your business at the first sign of trouble. 

Nonetheless, you should also be aware that the specific amount of an owner's investment can often be negotiated so that a lesser percentage of financing may come from the owner. The stated basis for granting an SBA loan guarantee are the borrower's character, credit, management and ability to repay. Weakness in one area may be balanced by a strength in another area.

Providing Adequate Security for the Loan

The SBA states that a guarantee will not be denied merely because of inadequate collateral. However, in most instances, the private lender will still demand collateral, and the SBA's guarantee of a under-collateralized loan will be extended only if the business shows other favorable factors (e.g., solid cash flow) to support the creditworthiness of the borrower. 

The most important consideration for the SBA is whether the loan is collateralized to the maximum capability of the individual business owner. An owner who has valuable personal assets may be requested to pledge those assets as security on the business loan before the SBA agrees to guarantee the loan.

Agreeing to a Personal Guarantee

Unlike some of the other requirements, a personal guarantee by all owners having at least a 20 percent interest in the company is usually non-negotiable.

Expecting to Pay a (Slightly) Higher Price

A private lender can charge a slightly higher interest rate for an SBA-guaranteed loan than for a similar conventional loan. Although the interest rate is negotiated between the borrower and the lender, the interest rate is capped. The base rates are pegged to the prime rate, the rate or an optional rate. (Plus, the SBA prohibits extraneous fees.)

These are the maximum interest rates for fixed rate loans:

  • Loans greater than $50,000
    • Base rate plus 2.25 percent if the maturity is less than seven years
    • Base rate plus 2.75 percent if the maturity is seven years or more
  • Loans between $25,000 and $50,000
    • Base rate plus 3.25 percent if the maturity is less than seven years
    • Base rate plus 3.75 percent if the maturity is seven years or more
  • Loans of $25,000 or less
    • Base rate plus 4.25 percent if the maturity is less than seven years
    • Base rate plus 4.75 percent, if the maturity is seven years or more

In addition, the SBA's guarantee fee can be passed on to the borrower. The amount of the fee varies based upon the length of the loan and the amount of the loan

  • Maturity of one year or less: 0.25 percent
  • Maturity of more than one year
    • $150,000 or less, 2.0 percent
    • $150,000 -- $700,000, 3.0 percent
    • $700,001 -- $1,000,000, 3.5 percent
    • Over $1,000,000, 3.75 percent on guaranty portion over $1,000,000

While these additional costs may sometimes make an SBA-guaranteed loan more expensive than a conventional loan, you must also consider several counterbalancing factors. First, If the bank were to make the loan without the SBA guarantee, the lender might assess additional up front points because of the higher risk. SBA loans prohibit any points from being assessed in addition to the guarantee fee. Moreover, because of the SBA guarantee, many small businesses obtain a longer loan maturity term than they could otherwise obtain from a conventional lender.

Obtaining Longer-Term Financing

Most small businesses have considerable difficulty obtaining long-term financing. The fact is that lending to small businesses is a risky business.

One of the significant benefits of an SBA loan guarantee is that the government's backing will often support a longer-term loan. Instead of three- to five-year maximums on conventional bank loans to small businesses, the SBA guarantee commonly covers loans up to 10 years, and some real estate loans have maturities of up to 25 years. These longer terms provide much-needed cash flow consistency.

SBA Loan Guarantee Requirements

To be eligible for an SBA loan guarantee, a business must meet all of the following criteria:

  • small enough to fit SBA's criteria
  • a type of business acceptable to the SBA
  • be for-profit
  • be independently owned and operated
  • not be dominant in its industry
  • have applied for, and been denied, a conventional loan by a private lender
Warning

If at least two conventional lenders have denied your loan application, you may want to rethink, or rework, your business plans. Try to assess whether the denials are based upon factors that you can realistically overcome if your business gets going or whether adjustments in your plans are necessary.

Understanding the Size of a Small Business

To qualify for SBA assistance, your business should employ fewer than 500 employees. However, this general rule is subject to industry-by-industry variations. Below is a summary of the industry standards that the SBA has used in the past to define a business as "small." The SBA does provide more precise descriptions of small business size guidelines.

Tip

The SBA's definition of "small business" is broad enough to encompass approximately 99 percent of U.S. businesses.

Industry Standards
Manufacturing The maximum number of employees may range from 500 to 1,500 depending upon the type of product being manufactured.
Wholesaling The total number of employees may not exceed 100.
Providers of services Annual receipts may not exceed $7M to $35.5M, depending upon the industry.
Retailing Annual receipts may not exceed $7M to $35.5M depending upon the industry.
Construction Annual receipts may not exceed $7M to $33.5M, depending upon the industry.
Special trade construction Annual receipts may not exceed $7M.
Agricultural Annual receipts may not exceed $0.5M to $3.5M, depending upon the industry.

Businesses That Don't Qualify for an SBA Loan and the SBA Express Loan Program

Certain types of businesses are restricted from applying for or receiving loans directly from or guaranteed by the SBA. While you can make a good argument this means the government is picking winners and losers, unless legislation or regulations change, the facts remain.

Is Your Business Ineligible for SBA-Guaranteed Loans?

Restrictions fall into several categories.

Nonprofit, Education and Advocacy

  • Nonprofit organizations are ineligible to receive assistance except those qualified as sheltered workshops and operated in the interest of workers with disabilities. For-profit businesses owned by nonprofit organizations are eligible.
  • Businesses dealing in the creation, origination, expression or distribution of ideas, values, thoughts or opinions currently are not eligible. Specialty stores primarily engaged in selling products that promote or advocate ideas are not eligible. Specialized delivery, distribution or transportation concerns limiting themselves to distribution of ineligible material are also ineligible.
  • Academic schools are not eligible. However, technical, secretarial, vocational and trade schools are. Nurseries, kindergartens and preschools are also eligible provided they are not primarily (50 percent or more of the time) engaged in teaching academic subjects or ideology.

Unusual Business Models and Lending

  • Cooperatives are eligible provided size standards are met, the cooperative is a business in and of itself, and it carries on business activities for the financial benefit of its members who must also be eligible small business concerns. Consumer and marketing cooperatives are not eligible.
  • Concerns involved in speculation of any type (including real estate) are ineligible with the exception of a business, such as a grain elevator, which hedges in futures commodity trading in the course of ordinary operations and to protect itself from price fluctuations.
  • Concerns primarily engaged in lending or investment are not eligible with the exception of pawn shops which derive a minimum of 50 percent of their income from the sale of merchandise rather than the interest on loans.
  • Loans may not be made which would encourage a monopoly or be inconsistent with the accepted standards of freely competitive enterprise.
  • Pyramid sales distribution plans are ineligible.

Questionable Industry or Character

  • Gambling concerns are not eligible. However, otherwise eligible small business concerns which derive less than one third of their income from the following are eligible: (a) income or commissions derived from the sale of official state lottery tickets under a state license; (b) gambling that is licensed and supervised by state authority in those states where such activities are legal.
  • Loans to applicants engaged in illegal activities or production, servicing or distribution of illegal products are not eligible. In addition, applicants currently incarcerated, on probation or on parole or who have criminal cases pending against them are not eligible. Applicants whose probation or parole has been lifted solely because it is an impediment to obtaining a loan are not eligible.

Miscellaneous

  • Any Cable TV system broadcasting live station(s) or selecting which programs are to be transmitted is ineligible.
  • Automobile floor planning concerns are not eligible.

Accessing Express Loan Programs for Quick Financing

The SBAExpress program gives small business borrowers an accelerated turnaround time for the SBA's review of a loan application. In general, a response to your application will occur within 36 hours. In addition, lower interest rates are often available to you when you apply through an Express program.You'll want to thoroughly read about the Express loan option before you consider it for your business.

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