Top 3 Deal Breakers of an SBA Loan

Companies looking for up to $5 million in loans might want to consider choosing a lender who offers Small Business Administration (SBA) loans. These loans are guaranteed by the SBA which helps banks lend money when cash flows and collateral may not be sufficient for traditional financing. Additionally, because these loans are guaranteed by the SBA, lenders are willing to provide longer terms, longer amortization, and larger loan amounts than they otherwise could under a conventional credit facility. However, there are three major reasons why companies may try to avoid the SBA structure.

1. Equity is required

The SBA requires the borrower (or the owner of the borrower) to put in only 10% equity for acquisitions, but lenders are ultimately in charge of setting the equity threshold. Many times, these lenders will choose to require more equity, often up to 20%. In order for cash equity to be valid for the SBA, borrowers will need to provide 60 days of bank statements showing a balance of at least the amount of required cash equity. If the corporate borrower does not have enough cash, then statements will need to be provided showing that the business owners/guarantors will be providing the cash from their personal accounts.


Lenders must follow all regulations of the SBA or else the lender will risk qualifying for the SBA guarantee. For example, the SBA will not allow draws on lines of credit to count as equity. This is very important because many borrowers have their checking accounts sweep to their lines of credit to avoid interest costs. However, if the borrower happened to have cash in an account, but also had balances on their lines of credit, the SBA rules allow the cash in the deposit account to act as equity, so long as it was available in the account for at least 60 days.


Cash is fungible; however, it will be very important to walk through your steps and thought processes with your lender. They are the ones who oversee this process to make sure all the rules are followed in a way that limits the risk of them failing to secure the SBA guarantee.

2. Seller notes can only count for half of equity

If the acquirer doesn’t want to use their own cash for the full down payment, then the SBA rules allow seller notes to count towards the down payment; however, the seller notes can only count for up to half of the down payment. For example, if the equity portion required by the SBA was $200k, then a seller note could count up to $100k and the borrower would need to provide at least $100k in cash.


A seller note must be deeply subordinated in order to qualify as equity. A normal seller note requires interest and principal back to the seller quickly. However, a seller note is considered deeply subordinated when the acquirer is prohibited from making interest payments as well as principal payments. When this happens, the acquirer could agree to accrue interest instead of paying it out to the borrower.

3. Personal guarantees are required

All SBA loans require personal guarantees of the owners; however, SBA backed loans have guarantees that are more onerous than typical loans. The SBA requires that any unencumbered real estate of the guarantor must be encumbered with a lien including a personal residence.


If the residence doesn’t have any equity or if there are additional liens such as an existing equity line of credit, then the SBA will move forward either with a diminished lien or without a lien at all. Often owners prefer not to do this because it restricts their ability to pull liquidity out of the rising value of their homes.

SBA loans have many benefits

Despite these reservations, borrowers still choose to move forward with SBA loans because they allow for longer terms and larger loan amounts. In certain cases, the SBA loan program is the difference between getting financing or not getting financing. In other cases, the SBA loan program allows the lender to provide a 10 year term, which is double the common conventional loan term. The longer term means that the payments are much smaller and gives the borrower more flexibility in the long run.


In a recent deal facilitated by Cerebro Capital, a middle market company needed $2 million for acquisition financing. Based on the lack of available collateral, most lenders were unable to provide the full amount needed. Out of five commercial lenders, only two were able to provide term sheets that were compelling. Both of them used an SBA backed loan program, which offered the borrower a larger loan amount, a ten year term, six months interest only, and a three year fixed rate on the loan. The longer term and the fixed rate was ultimately more attractive to the borrower than the disadvantages of the SBA structure.

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