Finance 101 - 10.24.2016

Can I Get an SBA Loan?

SBA Underwriting Process Explained

SBA loans are a viable way to get affordable, long-term capital. But the application process can be daunting (check out our guide here), and frustrating if it ends in rejection. What's more, plenty of small business owners think they can qualify for an SBA loan when, in reality, they aren't even eligible.

So the $64,000 question is whether you can get an SBA loan. And the answer to that is complicated—but we're going to help unpack it.

But in case your strapped for time, the short answer is to get an SBA loan, you're going to need (at a minimum):

  • A debt service coverage ratio over 1.25 (and a global DSCR of over 1.0)
  • A strong personal and business credit score (typically 680+ FICO)
  • A positive net worth of your business
  • Substantial unencumbered collateral (whether in the business or personal)
  • Few (if any) derogatory marks on your credit

Details below.

Overview

To start with, the SBA Small Business Loan Program is not actually a program for origination small business loans, it's a program for guarantying small business loans. So the SBA does not originate loans, it merely guarantees them—up to 85% of the loan amount. But the lender (almost always a bank or a credit union) still needs to review and approve the loan.

As a practical matter, this means that to get approved for an SBA loan, you actually need two sets of approvals: one from the lender and another from the SBA itself.

Unsurprisingly, the SBA sets credit standards for SBA 7(a) Small Business Loans because the SBA is only willing to guaranty certain small business loans. The guaranty criteria it uses are set forth in SOP 50 10 5(F).

Practically speaking, this means your application will get ping-ponged between the bank and the government, which is part of the reason for the "legendary" red tape. However, this ping-ponging will vary based on the loan size and the guaranty amount.

There are actually three types of SBA 7(a) Small Business Loans: "Standard Loans," "Small Loans," and "SBA Express." 

Standard Loans. If a loan is greater than $350,000, it is treated as a Standard Loan, which will take longer for the SBA to process. For Standard Loans, the SBA will guarantee up to 85% for loans of $150,000 or less, and up to 75% for loans above $150,000.

Small Loans. If the loan amount is less than or equal to $350,000, it's eligible for the Small Loan Advantage Program, which means it can be fast-tracked if it meets certain criteria. Like the Standard Loan, the SBA will guarantee up to 85% for loans of $150,000 or less, and up to 75% for loans above $150,000.

SBA Express Loans. If a loan is less than or equal to $350,000, it's eligible for the SBA Express program. The SBA commits to giving a guaranty decision on an Express Loan within 36 hours of submission by the lender. The trade off, however, is that the SBA will only guaranty 50% of the loan amount, which means it will be harder to get the loan or it will come with a higher rate.

How to Get an SBA 7(a) Small Loan

The SBA 7(a) Small Loan Program is an abbreviated application process for smaller loans that are comparatively easy to approve. They're pre-screened based on financial metrics, then the loan is analyzed for affordability by both the SBA and the lender.

SBA's Pre-Screen

For SBA 7(a) Small Loans, the first step is to assess your creditworthiness using a blended credit model consisting of a mix of consumer credit data, business credit data, borrower financials, and application data. Basically, this is a programmatic small-business underwriting model designed to pre-screen whether you're an easy approval.

If you're above the minimum score required, you're eligible for the 7(a) Small Loan Program, and your application will be submitted through the SBA's E-Tran system, which allows for faster processing.

If you don't meet the minimum score, your application can still be processed, but it needs to go through the more rigorous "Standard Loan" process... and the ominously named SBA 7(a) Loan Guaranty Processing Center.

So what's the minimum score? Good question. It's a moving target. Specifically, the minimum score shifts based on the lower end of the SBA's current portfolio. So if the lower end of the SBA's portfolio is full of very creditworthy businesses (as you would expect if, e.g., there were a credit crunch), it's harder to qualify for the SBA Small Loan Program. But if you're curious, the score itself is published on the SBA's website for lenders:


SBA Minimum Affordability

For SBA 7(a) Small Loans, the next step is to assess affordability. Here, the SBA requires that the lender document whether you can repay your loan, and imposes five minimums requirements:

  • Your global debt service coverage ratio must be greater than 1
  • Your global cash flow coverage ratio must be greater than 1 (unless you're asking for less than $50,000)
  • The lender must examine the the business's time in business under current management
  • The lender must examine the current management's expertise in the industry
  • The lender must examine the guarantors' finances

Note that for these last three, the SBA doesn't require a particular metric... but that doesn't mean it doesn't matter.

Calculating the Global Debt Service Coverage Ratio

The SBA proscribes the formula to calculate debt service coverage ratio: Operating Cash Flow (which itself is defined as earnings before interest, taxes, depreciation, and amortization, aka "EBITDA") divided by Debt Service (which is defined as the future principal and interest payments on all business debt, including the new SBA loan).

What makes it "global" debt service coverage ratio? Well, it's global because the the lender will look at your business's operating cash flow, as well as the cash flows from every other related business and guarantors. And will do the same for debt service. This can be great if you're got other related businesses with strong cash flows... less so if you've got lots of personal debts.

So the calculation is:

Note, however, that the SBA allows operating cash flow to be calculated on either a historical or projected basis. That's good for high-growth companies, whose historical operating cash flow will be much lower than their projected operating cash flow.

In other words, in order to be eligible for the "Small Loan" program, your cash flows need to be at least equal to your debt service.

Calculating the Global Cash Flow Coverage Ratio

The SBA doesn't actually even define cash flow coverage ratio in its lending guidance, but the generally accepted formula is Operating Cash Flows divided by the Cash Obligations of the business, which will include things like debt service, but also liabilities, dividends, and ongoing concerns costs. 

In other words, in order to be eligible for the "Small Loan" program, your business has to be solvent.

Lender Underwriting

Okay, so you meet the SBA's requirements. You're gonna get the loan, right?

Not so fast!

As with most minimum requirements, the SBA's minimum requirements for a 7(a) Small Loan are just minimums. The actual SBA lender is still required to underwrite you—according to the same criteria it uses to underwrite other, similar small business loans.

These standards will vary from lender to lender, though SBA requires lenders to look at:

  • Affordability (see above)—for banks, this is almost always greater than 1.25
  • A statically valid credit scoring model—for banks, this is almost always greater than 680 FICO, as well as some business credit scoring information. In fact, it has to include more than just personal credit information under the SBA criteria
  • The business's debt to worth ratio and equity—for banks, this is almost always at least less than 1
  • The business's payment history—for banks, this almost always entails no recent missed/late payments and no bankruptcy in the past few years.

Once those are all evaluated, your file will be sent up to SBA for a yes/no on whether the SBA will guarantee the loan.

How to Get an SBA 7(a) Standard Loan

As the name suggests, the 7(a) Standard Loan follows the SBA's more rigorous "standard" underwriting methodology. Unlike the 7(a) Small Loan program, there is no credit-prescreen for the SBA 7(a) Standard Loan.

The 7(a) Standard Loan underwriting process is similar to the Small Loan process, but more robust.

How much more robust? A lot.

SBA Minimum Affordability

As an initial matter, the lender must show that you have a debt service coverage ratio of greater than or equal to 1.15 on either an historical or projected basis. In other words:


And remember, that's just the minimum. Just because you meet it doesn't mean the lender will give you a loan.

Most banks require at a debt service coverage ratio of at least 1.2 to 1.3 to approve the loan. The rationale being: they want you to have a little padding in case something goes wrong.

Lender Underwriting

Once you clear the minimum requirements, the lender still needs to run you through its standard underwriting process, which according to the SBA must analyze and document:

  • The length in business under current management
  • The management team's expertise in the industry
  • The business's ability to repay, with an in-depth analysis of the cash flows of the business
  • The historical and projected Current Ratio, Debt/Tangible Net Worth Ratio, Debt Service Coverage Ratio, and any other ratios the lender considers relevant
  • Working capital adequacy to support projected sales growth over the next 12 months
  • Adequacy of collateral
  • Explanation for refinancing any debts as part of the loan request (discouraged)

The lender must also document any red flags, including:

  • 90+ delinquencies
  • Trade disputes
  • Government citations that would preclude normal business operations (e.g., tax liens)
  • Any liens, judgments, or bankruptcies

It's a fair assumption that if you've got any of the above red flags, it's going to serously impair your chances of getting an SBA loan.

How to Get an SBA 7(a) Express Loan

The SBA 7(a) Express Loan Program is like the other SBA 7(a) Programs, but with much less ping-ponging back and forth. Specifically, the SBA authorizes SBA Express Lenders to make credit decisions without prior SBA review (though the SBA will continue to review early defaults). The catch is, however, that the SBA will only guaranty 50% of the loan, which means it's riskier for the lender and therefore more expensive for you.

Lender Underwriting

The basic SBA guidance for 7(a) Express Loans is that the lender must:

  • Demonstrate that there is a reasonable assurance of repayment
  • Use appropriate, prudent and generally accepted industry credit analysis processes and
  • procedures
  • Use procedures consistent with its similarly sized non-SBA loans

In short, it's not just a free-for-all with government money. The lender has to treat it's 7(a) Express Loans like any other similar loan it would make.

Personal Guarantees

Anyone who owns more than 20% of the business (spouses count as one owner) must personally guaranty the full loan amount, and the lender may require people who own less than 20% to guaranty as well.

Collateral

SBA requires the SBA to use "commercially reasonable and prudent practices to identify collateral items, which conform to procedures at least as thorough as those used for their similarly-sized non-SBA guaranteed commercial loans," though ultimately defers to the lender.

Note: the SBA doesn't just take your word for it on how much collateral is worth. They'll appraise it using third-party appraisers, as well as a set of valuation criteria. Expect a haircut on the value of your collateral, even if it's brand new.

Loans of $25,000 or Less

No collateral is required for loans of $25,000 or less. But that doesn't mean the lender can't ask for it anyway.

Loans between $25,000 and $350,000

For SBA 7(a) loans between $25,000 and $350,000, the lender must follow it's normal collateral policies and procedures, as well as:

  • Take a first-position lien on all assets financed with the loan proceeds
  • Take a first-position lien on all the applicant's fixed assets (e.g., land, buildings, and equipment)
  • Take a first-position lien on all the applicant's trading assets (e.g., inventory) if it does so for similarly sized non-SBA loans

Loans Greater Than $350,000

For SBA 7(a) loans over $350,000, the SBA requires the lender to collateralize the loan to the maximum extent possible.

If the business's fixed assets do not fully secure the loan, then the lender may include trading assets, but must take as collateral the principals' available equity in any personal real estate. In other words, if you're applying for an SBA 7(a) loan of over $350,000, you have to show either substantial fixed business assets or pledge your house as collateral.

No Collateral?

In theory, at least, the SBA will not reject a loan solely for lack of collateral. In practice, however, a no-collateral or low-collateral loan is going to be harder to get through the strike zone. That's because the SBA won't reject a loan for no collateral if that's the only thing wrong with the loan—but no borrower is perfect, so the lack of collateral is going to be a significant problem.

Summary

To get an SBA loan, you're going to need (at a minimum):

  • A strong debt service coverage ratio (at least 1.0, but likely over 1.25)
  • A strong personal and business credit score (typically 680+ FICO)
  • A positive net worth of your business
  • Substantial unencumbered collateral (whether in the business or personal)
  • Few (if any) derogatory marks on your credit

And, of course, a little bit of patience! Depending on which SBA loan program you're using, you can expect it to take between 1-2 months (on the low end) to up to a year (on the high end), with most borrower's reporting about 2-4 months.

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