7(a) loans are the most basic and most often used of those in the SBA’s business loan program. The purpose of this loan is to help start-up and existing small businesses with financing, guaranteed for a variety of general business purposes.
The first thing you should understand about this loan is that the SBA does not make loans itself, but rather guarantees loans made by participating lending institutions. In this way, taxpayer funds are only used in the event of borrower default. This reduces the risk to the lender but not to the borrower, who remains obligated for the full debt, even in the event of default.
All 7(a) loans are provided by lenders who participate with SBA in the program. While not all lenders choose to participate, the majority of American banks do. These lenders are called participants, and offer the loan under a guarantee basis. This means they are provided by lenders who choose to structure their own loans by SBA’s requirements and receive a guarantee from SBA on a portion of this loan. The lender and SBA, then, share the risk of any potential default. The guarantee only covers payment default; it does not cover imprudent decisions by the lender or misrepresentation by the borrower.
How it Works
The business applies to a lender for their financing. The lender decides if they will make the loan internally or if the application has some weaknesses which, in their opinion, will require an SBA guaranty were the loan to be made. The guaranty which SBA provides is only available to the lender. It assures the lender that in the event the borrower does not repay their obligation and a payment default occurs, the government will reimburse the lender for its loss, up to the percentage of SBA’s guarantee. Under this program, the borrower remains obligated for the full amount due.
All 7(a) loans must meet 7(a) use criteria. The business gets a loan from its lender with a 7(a) structure and the lender gets an SBA guarantee on a portion or percentage of this loan. If you are awarded a 7(a) loan, you can use the loan proceeds to help finance a large variety of business purposes, but there are some restrictions:
Uses of 7(a) Loans
Basic uses for 7(a) loan proceeds include:
- Long-term working capital used to pay operational expenses, accounts payable and/or to purchase inventory
- Short-term working capital needs, including seasonal financing, contract performance, construction financing and exporting
- Revolving funds based on the value of existing inventory and receivables, under special conditions
- Purchase of equipment, machinery, furniture, fixtures, supplies or materials
- Purchase of real estate, including land and buildings
- Construction of a new building or renovate an existing building
- Establishment of a new business or assist in the acquisition, operation or expansion of an existing business
- Refinancing of existing business debt, under certain conditions
SBA loans cannot be used for these purposes:
• Refinancing existing debt where the lender is in a position to sustain a loss and SBA would take over that loss through refinancing
• Execution of a partial change of business ownership or a change that will not benefit the business
• Reimbursement of funds owed to any owner, including any equity injection or injection of capital to continue the business until the SBA-backed loan is disbursed
• Payment of delinquent state or federal withholding taxes or other funds that should be held in trust or escrow
• Anything not considered to be a sound business purpose as determined by SBA
• If you are unsure whether or not your anticipated use of funds is allowed, check with your SBA-approved lender
To be eligible for assistance, businesses must:
• Operate for profit
• Be small, as defined by SBA
• Be engaged in, or propose to do business in, the United States or its possessions
• Have reasonable invested equity
• Use alternative financial resources, including personal assets, before seeking financial assistance
• Be able to demonstrate a need for the loan proceeds
• Use the funds for a sound business purpose
• Not be delinquent on any existing debt obligations to the U.S. government
For a detailed list of which businesses are not eligible and for special considerations, please visit: http://www.sba.gov/content/7a-loan-program-eligibility.
7(a) Loan Application Checklist
Once you have decided to apply for a loan guaranteed by the SBA, you will need to collect the appropriate documents for your application. The SBA does not provide direct loans. The process starts with your local lender, working within SBA guidelines.
Use the checklist below to ensure you have everything the lender will ask for to complete your application. Once your loan package is complete, your lender will submit it to the SBA. Read more about the SBA loan application process.
1. SBA Loan Application – To begin the process, you will need to complete an SBA loan application form. Access the most current form here: Application for Business Loan - SBA Form 4.
2. Personal Background and Financial Statement – To assess your eligibility, the SBA also requires you complete the following forms:
3. Business Financial Statements – To support your application and demonstrate your ability to repay the loan, prepare and include the following financial statements:
• Profit and Loss (P&L) Statement – This must be current within 90 days of your application. Also include supplementary schedules from the last three fiscal years.
• Projected Financial Statements – Include a detailed, one-year projection of income and finances and attach a written explanation as to how you expect to achieve this projection.
4. Ownership and Affiliations – Include a list of names and addresses of any subsidiaries and affiliates, including concerns in which you hold a controlling interest and other concerns that may be affiliated by stock ownership, franchise, proposed merger or otherwise with you.
5. Business Certificate/License – Your original business license or certificate of doing business. If your business is a corporation, stamp your corporate seal on the SBA loan application form.
6. Loan Application History – Include records of any loans you may have applied for in the past.
7. Income Tax Returns – Include signed personal and business federal income tax returns of your business’ principals for previous three years.
8. Résumés – Include personal résumés for each principal.
9. Business Overview and History – Provide a brief history of the business and its challenges. Include an explanation of why the SBA loan is needed and how it will help the business.
10. Business Lease – Include a copy of your business lease, or note from your landlord, giving terms of proposed lease.
11. If You are Purchasing an Existing Business – The following information is needed for purchasing an existing business:
• Current balance sheet and P&L statement of business to be purchased
• Previous two years federal income tax returns of the business
• Proposed Bill of Sale, including Terms of Sale
• Asking price with schedule of inventory, machinery and equipment, furniture, and fixtures
7(a) Loan Amounts, Fees & Interest Rates
The specific terms of SBA loans are negotiated between a borrower and an SBA-approved lender. In general, the following provisions apply to all SBA 7(a) loans.
7(a) loans have a maximum loan amount of $5 million. SBA does not set a minimum loan amount. The average 7(a) loan amount in fiscal year 2012 was $337,730.
Loans guaranteed by the SBA are assessed a guarantee fee. This fee is based on the loan’s maturity and the dollar amount guaranteed, not the total loan amount. The lender initially pays the guarantee fee and they have the option to pass that expense on to the borrower at closing. The funds to reimburse the lender can be included in the overall loan proceeds
• On loans under $150,000 made after Oct. 1, 2013, the fees are set at zero percent.
• On any loan greater than $150,000 with a maturity of one year or shorter, the fee is 0.25 percent of the guaranteed portion of the loan.
• On loans with maturities of more than one year, the normal fee is 3 percent of the SBA-guaranteed portion on loans of $150,000 to $700,000, and 3.5 percent on loans of more than $700,000. There is also an additional fee of 0.25 percent on any guaranteed portion of more than $1 million.
The actual interest rate for a 7(a) loan guaranteed by the SBA is negotiated between the applicant and lender and subject to the SBA maximums. Both fixed and variable interest rate structures are available. The maximum rate is composed of two parts: a base rate and an allowable spread. There are three acceptable base rates: a prime rate published in a daily national newspaper*, London Interbank One Month Prime plus 3 percent, and an SBA Peg Rate.
Lenders are allowed to add an additional spread to the base rate to arrive at the final rate. For loans with maturities of shorter than seven years, the maximum spread will be no more than 2.25 percent. For loans with maturities of seven years or more, the maximum spread will be 2.75 percent. The spread on loans of less than $50,000 and loans processed through Express procedures have higher maximums.
*All references to the prime rate refer to the base rate in effect on the first business day of the month the loan application is received by the SBA.
Percentage of Guarantee
SBA can guarantee as much as 85 percent on loans of up to $150,000 and 75 percent on loans of more than $150,000. SBA’s maximum exposure amount is $3.75 million. Thus, if a business receives an SBA-guaranteed loan for $5 million, the maximum guarantee to the lender will be $3.75 million or 75%. SBA Express loans, which we will get into more in a later post, have a maximum guarantee set at 50 percent.
Special Types of (7a) Loans
SBA offers several special purpose 7(a) loans to aid businesses. In future posts we will explore some of the more common types of special purpose loans:
• Small Loan Advantage and Community Loan Advantage
• Patriot Express Loan
• SBA Express Loan
There are a lot of details that go into the loan process. Now that you have a general understanding, the best thing to do is to contact your local SBA or SBDC office to help you understand options from community and national banks. They can also provide guidance about loan eligibility and application requirements. If you are a veteran or a woman-owned business, you can get specialist advice about programs that meet your needs at a local Veterans Business Outreach Center or Women’s Business Center.