The Role of Collateral for SBA Loans

I like to tell small business owners that SBA loans offer them lower down payments, longer repayment terms, and easier qualifying criteria than conventional bank loans, because I think that is a concise description of the government guaranteed SBA 7(a) loan program. Sometimes conventional bank financing is not available to a small business due to the newness of the business, due to insufficient capital investment by the owner(s), due to unstable cash flow, or just because the bank does not have an appetite for long-term small business loans. There are other times, however, when the banker requires more collateral.

Because the SBA loan program was designed to provide financing to small businesses which have a promising future, but which do not have the resources a conventional bank lender may require, the following guidelines govern the SBA lender’s collateral requirements:

• A loan request is not to be declined solely on the basis of inadequate collateral. In fact, one of the primary reasons lenders use the SBA-guaranteed program is for those Small Business Applicants that demonstrate repayment ability but lack adequate collateral to fully repay the loan if the loan defaults.
• SBA does not permit its guaranty to be used as a substitute for available collateral. SBA requires that the lender collateralize the loan to the maximum extent possible up to the loan amount. If business assets do not fully secure the loan, the lender must take available personal assets of the principals as collateral.
• When loan proceeds will be used to purchase assets, a first security interest in those assets must be obtained. When loan proceeds will be used to refinance existing debt, the loan must be secured with at least the same security as the debt that is being refinanced.
• SBA considers a loan as “fully secured” if the lender has taken security interests in all available assets with a combined “liquidation value” up to the loan amount. “Liquidation value” is the amount expected to be realized if the lender took possession after a loan default and sold the asset after conducting a reasonable search for a buyer and after deducting the costs of taking possession, preserving and marketing the asset, less the value of any existing liens. Further, if there is a collateral shortfall on the SBA-guaranteed loan and there is other available collateral, the lender will be required to take such collateral, including personal assets of the principals.

There are other details and exceptions to policy which an SBA lender can identify for the small business loan applicant when applying these guidelines. A borrower in Texas, for instance, cannot be required to pledge a lien on their personal residence due to homestead laws in the state which prevent business lenders from taking liens on personal homes. Texas lenders can, however, place liens on personally-owned investment real estate to shore up an insufficient collateral position for the SBA loan.

We are also aware of other collateral requirement changes being instituted by SBA as of 1/1/14:

• For loans of $25,000 or less, SBA lenders are not required to take collateral.
• For loans over $25,000, up to and including $350,000, the lender must follow the collateral policies and procedures included in its credit policy for its non-SBA guaranteed loans, but at a minimum the lender must obtain a lien on the applicant’s fixed assets to secure the loan.
• For loans over $350,000, the SBA lender must collateralize the loan to the maximum extent possible up to the loan amount. If fixed assets do not fully secure the loan, the lender must take available equity in the personal real estate of the principals as collateral.

As you can see, the SBA lender must stay abreast of the latest SBA directives for the program; yet, the small business borrower can almost always count upon more liberal guidelines for loan approval and terms than with conventional bank financing.