How Do Banks Evaluate SBA Loan 7a Applications?

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The evaluation process of an SBA 7a loan can seem mysterious.  Almost like a lottery where some win, and some don’t.  That’s what it seems like, but there actually is a method to the madness.  Quite simply, the SBA wants its lending partners to make “good loans” that have a high probability of being repaid.  So what do factors do lenders look at when evaluating SBA 7a loan applications?

  1.  Credit – Lenders usually want a credit score over 650 at the minimum, and 700 is preferred.  In my time as a underwriter and lender, I saw lots of people with bad credit.  The majority of the bad credit scores were rightly earned.  By that I mean that they had missed payments, or worse, failed to repay debt.  Some simply had too much debt with lots of inquiries (which we interpreted as a sign of possible desperation).  The only cases of bad credit where we might make an exception were those with extenuating circumstances, such as medical debt.  Overall, lenders do believe that is you’ve failed to repay debt in the past, it’s much more likely to happen again in the future.
  2. Collateral – While the SBA doesn’t require debt to be 100% secured, having collateral to offer (usually in the form of cash, equipment, or real estate) can help what could otherwise be considered a borderline applicant (marginal credit or cash flow, or questionable qualifications).  The best feature of SBA 7a loans is that they can be granted without sufficient collateral, which is what makes 7a loans so popular.
  3. Cash Flow – Cash Flow is the hardest aspect to grasp when it comes to underwriting an SBA 7a loan (or really any small business loan, for that matter).  While the SBA has specific guidelines for cash flow coverage ratio (defined as operating cash flow divided by debt service), the truth is that depending on who is doing the calculation, that number will vary.  The reason for this is that there are some items that can be added or subtracted from cash flow, and sometimes underwriters will disagree on what those numbers are. For example, it is common to include an “owners draw”, which represents the amount that an owner would need to take from their business in order to pay their personal bills.  Some underwriters will be very conservative about that number, assuming that a business owner will need a higher draw, while others will assume that a business owner only need to draw funds to pay debt listed on the credit report.  The difference between those numbers can be huge, which you consider school expenses, home maintenance, auto maintenance, clothing, meals etc.  So, while the SBA wants to see a debt service ratio of 1.15x (1.00x for global cash flow) for loans over $350K, as I’ve noted above, these numbers can be “massaged” depending on the underwriter or standards set by the lender.  Loans under $350K don’t have a specific debt service coverage requirement, but instead rely on a scoring system called the FICO Small Business Scoring Service.  This score is similar to a personal FICO score, except it also evaluates the business as well.
  4. Management ExperienceIf you’ve been running your business successfully for a number of years, this won’t be an issue for banks.  For startups, however, banks and the SBA want to know that if they approve you for an SBA 7a loan, that you have the skills and experience required to run the business.  An example of a strong candidate would be someone who has managed a franchise restaurant for 5 years, and is not going to open their own.  They know the business inside and out, giving the bank confidence that the loan will be repaid.  An example of a weak candidate would be an accountant deciding that he wants to open a franchise restaurant.  While he would be adept at the book keeping side, a lender may be concerned that an accountant doesn’t know all that is involved with a running a successful restaurant.
  5. Capital – This is not paramount for SBA loans, since most only require 10% down, and many cases people even borrow it.  There are all sorts of rules for “injection”, but banks eager to make SBA loans tend to find a way to get it done.

Jason Milleisen can answer your questions about applying and being approved for an SBA loan.  Feel free to call (toll free 1-877-436-4533) or email me (jason@jasontees.com).   If you retain me to help you with your financing needs, I’ll give you a rebate after your loan closes equal to 10% of my commission, up to $500.

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