SBA Loans: The main thing you need to remember

This “logic” should help you see everything differently

Photo by bruce mars on Unsplash

I remember working as a banker years ago, and one of the biggest red flags for us was when people reached out asking for an “SBA loan” specifically.

In retrospect, we were probably just being a little too judgmental as few people know about this, but the reason we hated it is because of how people “view” SBA Loans.

When you speak to the typical business owner, or aspiring business owner, they’re always under the impression of how these are easier to get — mainly because they’re “designed” for the riskier crowd.

It’s almost like they think all other “underwriting” logic goes out the window, I’m here to tell you, it doesn’t quite work like that.

Instead, it’s simply in place to help with one main issue:

Collateral deficiency

From my experience, the most “common” way SBA Loans are used, is during acquisitions.

When you’re purchasing another business, there’s generally some “blue sky” involved, primarily because of how most businesses are valued.

If the entity generates $200K/year in profits, the typical price is going to be in the $700K range, as 3.5x profit multiplier is a “common” valuation tactic.

Seeing that, if the business you’re buying doesn’t have roughly $1M in assets (that can be used as collateral), then banks are hesitant to touch it.

They always want a “secondary form of repayment” in place, being able to recoup their funds if you’re unable to repay, and collateral is a big part of that.

It’s almost a “requirement” to get approved, which is where “SBA Loans” come in.

Now, if everything else makes sense, the SBA Guaranty will serve as a replacement for collateral.

This provides them with everything necessary to mark off the “secondary form of repayment” aspect they’re looking for, but here’s the thing:

Everything else remains the same

If there’s one takeaway I’m trying to say with this, it’s how you should never assume SBA Loans “mitigate risk”.

Before getting to the collateral section of an analysis, all underwriting is the same for “non-SBA” loans and “SBA” loans, mainly because they want to see it’s a good deal.

They’re not going to approve a “dud” just because the SBA guarantees it, primarily because too many bad loans will hurt their status with the SBA.

That’s a “concern” every bank has to deal with, so to get around that, they always underwrite loans in a way that validates “cash flow coverage” first.

They want to show how there was a very “high level of certainty” that the loan would be repaid without the SBA stepping in, and in the rare event they’re needed, then it’s not a huge deal.

Nobody’s going to be “100% accurate” in this field, but this is important for you to remember, as it’ll help see how you need to “prepare” for funding requests.

Most like to go in with the vaguest “projections” possible, just thinking it’ll be a shoe-in as SBA covers it, that immediately ruins your chances of getting the funds you need.

When bankers can see there’s no “meat” behind the projections, then they don’t trust the numbers, naturally declining your request because of it.

In addition to that, you have to consider all other items that go into their “checklist”, including:

• Competitor/Market Analysis
• Risk mitigation
• Product-market fit
• Etc…

All things I elaborate on in this article:

3 common fundraising mistakes (and how to avoid them)

But at the end of the day, the “logic” I’m trying to share is the most important part of it.

Everybody focuses on “SBA Loans” as they think they’re “easy” and “designed for new businesses”, not the case.

Instead, it’s simply a way to mitigate an issue most companies run into, which is lack of collateral coverage — and that’s where SBA guarantees come in.

Seeing this, I’m not saying you need to avoid SBA altogether, I’m just saying you need to go into each request knowing how everything works.

Most put in minimal effort “preparing” for their loan request, simply because they think the SBA aspect is going to make life easier, not the case.

You still need to do the “dirty work” upfront, including:

• Solid projections
• Risk mitigation
• Market analysis
• Product-market fit
• Etc…

That way you can show banks it’s a good deal, then let them use SBA guarantees to mitigate any other risks you don’t have the luxury of doing yourself (i.e. collateral deficiency).

-Sean