Awhile back, I wrote about a case our client, Bill called me about. Remember Aunt Sadie? Probably not, but I do. Bill’s client was Aunt Sadie’s Salami Deli and Sadie had applied for a loan to remodel the commercial building. Since the 7(a) loan was under collateralized, Bill planned to take out a second on Sadie’s’ residence. The issue was complex, but fortunately, the requirements involving collateral value were detailed in SOP 50 10 6, and we resolved the dilemma.
Well, Bill called the other day about Sadie’s new venture: Aunt Sadie’s Soups. Although the business was a startup, Bill was eager to finance it and was looking into a 7(a) loan:
BILL. I told Sadie we could do the deal with 10% equity. Then I remembered that SBA had special requirements regarding equity in a startup. But I couldn’t find them in the new SOP. Did SBA move them to another section?
ME. I remember that section in 50 10 6. I can see it in my mind. Not only did it dictate the minimum equity injection requirements for certain loans, but it also listed what could and could not be counted as equity. I’m searching for that section in 50 10 7, and it’s just plumb gone. What does your loan policy say for similarly sized non-SBA loans? That’s what you need to use now.
FYI: Under 50 10 7, there is no requirement that a startup have a certain amount of equity, yet SBA does allow loans that finance 100% of costs, including startups. If you want to require a certain percentage of equity in a deal you certainly can, but SBA isn’t going to tell you how much. Still, to protect your institution, your credit policy should require a minimum, especially for startups.
BILL. Our conventional policy would require a huge amount of equity in the deal and the borrower would have to pledge the Taj Mahal as collateral. We always had SBA as an option for financing a startup because ordinarily we would avoid deals like this. Now my option is to ask for an exception to policy.
ME. This wasn’t the option Bill wanted, but it was the only one I saw available. He’d already told Sadie he could do the loan with 10% down. Now, without an exception to policy he couldn’t. Bill thanked me, but I could tell he was majorly disappointed.This got my dander up. I decided there must be a way Bill could get this loan done without resorting to an exception to policy. So we did a diligent search through 50 10 7, and I called Bill. It went like this:
ME. Hey Bill, got your SOP handy? The section requiring a certain amount of equity is gone, but check out page 110: “… the Lender may use its discretion to reduce the amount of equity and/or equity injection required if it determines that the Applicant needs leverage that exceeds the Lender’s conventional requirements.” Well in this case, Sadie cannot get her loan without a reduction in the amount of equity required. So because the amount of required equity is no longer in the SOP, you can do an SBA loan!
The Upshot. With the issuance of SOP 50 10 7, SBA doesn’t require borrowers to inject any part of the project cost. However, the institution’s own loan policy might require a down payment heftier than what SBA would have required. If your institution requires a certain amount of equity, fine and dandy. Determine what you want and put in your loan policy. You can no longer point to SBA’s policy as justifying an exception to your institution’s policy.
To get around this, we have page 110 in the SOP allowing 7(a) lenders to “… use discretion to reduce the amount of equity and/or equity injection required if it determines that the Applicant needs leverage that exceeds the Lender’s conventional requirements.” Say “Hello” to Aunt Sadie’s Soups and other deserving startups!