Underwriting is a crucial step in the process of obtaining a Small Business Administration (SBA) loan. SBA loans are designed to support small businesses by providing them with access to affordable financing. To ensure the integrity of the program and manage risk, the SBA has established specific underwriting guidelines that lenders must adhere to when evaluating loan applications. Here is an overview of SBA loan underwriting guidelines and what you need to know as a small business owner seeking an SBA loan.
One of the primary factors considered during SBA loan underwriting is the creditworthiness of the borrower. Lenders assess the personal credit history of the business owner(s) with significant ownership (usually 20% or more) in the business. A strong personal credit score demonstrates financial responsibility and reduces the lender’s risk.
2. Business Financials:
Lenders analyze the financial health of your business, including revenue, cash flow, profitability, and financial statements (income statement, balance sheet, and cash flow statement). They assess the business’s ability to generate income and repay the loan. Detailed and accurate financial records are crucial.
SBA loans often require collateral to secure the loan. However, the SBA typically doesn’t require borrowers to risk personal assets like homes. Instead, lenders may use business assets as collateral, such as equipment, inventory, or real estate. Underwriting assesses the value and adequacy of the proposed collateral.
4. Business Plan:
A well-crafted business plan is essential. It should outline your business’s purpose, goals, industry analysis, marketing strategy, and financial projections. A solid plan demonstrates your understanding of the business and your ability to manage it successfully.
5. Owner’s Equity Injection:
SBA loans may require a down payment or equity injection from the business owner(s). This demonstrates your commitment to the business and helps cover initial costs. The equity injection amount varies depending on the loan type and lender.
6. Character and Experience:
Lenders evaluate the character and experience of the business owner(s). They may consider your industry expertise, management skills, and past business experience. A strong track record can bolster your loan application.
7. Use of Proceeds:
Lenders scrutinize how you intend to use the loan funds. Common uses include working capital, purchasing inventory or equipment, refinancing existing debt, or funding expansion. The proposed use should align with the loan’s purpose.
8. Affiliation and Eligibility:
Under SBA guidelines, your business must meet certain eligibility criteria, such as size standards, industry restrictions, and legal structure. Lenders ensure that your business qualifies for the specific SBA loan program you’re applying for.
9. Repayment Ability:
Lenders assess your business’s capacity to repay the loan. This involves reviewing your historical financial performance, cash flow projections, and the debt service coverage ratio (DSCR). A DSCR above 1.0 indicates your business can cover its debt payments comfortably.
10. Legal and Regulatory Compliance:
Your business must comply with federal, state, and local laws and regulations. Lenders will verify that your business operates legally and has all necessary licenses and permits.
11. Environmental Considerations:
For some loans, particularly those involving real estate, lenders may assess environmental risk. Properties with potential environmental issues may require additional assessments or mitigation.
12. Personal Guarantees:
In many cases, lenders may request personal guarantees from business owners, which means they are personally responsible for repaying the loan if the business cannot. The extent of personal guarantees can vary.
Navigating the SBA loan underwriting process can be complex, but understanding these guidelines is essential for a successful application. Working closely with your lender and providing thorough documentation is key. Keep in mind that SBA loan programs offer various options, such as the 7(a) loan program or the CDC/504 loan program, each with its specific underwriting requirements. It’s advisable to consult with experienced financial advisors or lenders who specialize in SBA lending to guide you through the process and increase your chances of securing the financing your small business needs.