Before applying for a loan from the Small Business Administration (SBA), it is important to consider the various pros and cons of each type of SBA product. Generally, there are two types of SBA Loans: the 504 Loan and the 7(a) Loan. Each loan has different benefits that can help small business owners grow and maintain their business. In this post, we will examine the 7(a) Loan.
Eligibility Requirements
If you can demonstrate a need for funds and have a sound business purpose in mind, you’re on the right track. To be considered eligible for an SBA 7(a) Loan, your business must:
- Meet the SBA’s size standards and be considered small within your particular industry
- Operate for profit
- Have reasonable equity to invest
7(a) Loans are not available for passive real estate investments, pyramid sale distribution plans, businesses deriving more than one-third of gross annual revenue from legal gambling activities, or businesses engaged in any illegal activity.
Structure and Uses of the 7(a) Loan
The SBA does not make 7(a) loans directly to the borrower. Instead, 7(a) Loans are issued directly through authorized banking institutions where the SBA serves as a guarantor of the loan. 7(a) Loans offer flexibility, longer terms, and lower down payments than conventional or SBA 504 Loans.
An SBA 7(a) loan is a common option when borrowers are looking to:
- Access working capital
- Purchase new land, furniture, fixtures, or inventory
- Make leasehold improvements
Collateral, Limits, and Terms
- Collateral Requirements: For loans in excess of $350,000, the SBA requires that the lender collateralize the loan to the maximum extent possible up to the loan amount. This may include a lien on your personal real estate (residential and investment) or an assignment of a life insurance policy.
- Maximum Loan Amount: The maximum amount that may be loaned to a borrower through a 7(a) Loan is $5 million.
- Personal Guaranties: Personal guaranties of principal owners of the business attempting to secure a loan are required if an individual owns 20% or more of the business.
- Loan Terms: Typically 20 years for a loan for a real estate purchase, or 10 years for an equipment purchase.
- Down Payment: Borrowers are usually required to contribute a down payment equal to 10%–20% of the purchase price.
Guarantee Fees and Pre-Payment Penalties
One of the key aspects borrowers need to consider when seeking a 7(a) loan is the set of fees associated with taking out an SBA loan. The SBA charges a fee in exchange for its guaranty, which is passed along to the borrower and usually financed and built into the overall loan amount.
- Guaranty Fee: Typically between 2%–3.5% depending on the loan amount (a 3.5% guarantee fee is usually owed for loans above $700,000.00).
- Pre-Payment Penalty: Loans with a maturity of 15 years or longer usually include language prohibiting prepayment within the first three years without a penalty, though the penalty reduces as the loan matures.
If you have questions about securing an SBA loan or need legal guidance on business financing, please contact Kapadia Naik & Farhoudi or call us at 770-881-8081.