SBA 7(a) Loan Equity Requirements

When you apply for a small business loan like the SBA 7(a) loan program, you might be required to provide a 10% owner-equity injection.

What are the SBA 7(a) loan equity injection requirements, and how will you need to document your equity?

In this Q&A, Senior Vice President Andrea Dabney covers your most frequently asked questions about the equity injection requirements and documentation. You’ll find tips to keep this part of the application process moving forward and more!

Is a 10% owner equity injection always required for SBA 7(a) loans?

The SBA requires that owners provide a 10% equity injection when your business is a startup (less than two years of business operations) or when you’re buying an existing business. That being said, some lenders require a 10% equity injection for all SBA 7(a) loans.

There are two parts to the process: sourcing funds and spending funds. Sourcing the funds means showing where the available money is coming from. When you’re spending the funds, you need to show how they were spent with documents like receipts for inventory or office equipment. In essence, the SBA needs proof that you have the funds available and that you used them as promised.

What sources of owner equity are allowed for SBA 7(a) loans?

The SBA allows owner-equity funds to come from many different sources. They just have to be documented along with your expenses to ensure that they meet SBA requirements. Allowable sources for SBA 7(a)owner equity are:

  • Cash that’s not borrowed, such as:
    • Cash in your business account (for an existing business) or personal cash that’s provided for your business (such as from your personal savings).
    • Funds that are gifted or given to you, as long as it’s documented through a gift letter that the funds aren’t borrowed and there’s no repayment.
    • Stocks or securities that you withdraw or cash out, with the funds deposited into your personal or business account to use for your business.
    • In accordance with IRS and SBA requirements and your accountant, funds from retirement accounts such as:
      • Cash that’s withdrawn from your retirement account, as long as you can also pay any penalties for early withdrawal.
      • Cash that’s rolled over into your business from your retirement account, as long as this is done with a reputable organization that specializes in the rollover for business startups (ROBS) program.
  • Cash that’s personally borrowed, as long as the repayment comes from a source that’s not your business or your owner’s salary from the business. One example is owner equity from a home-equity loan when the home-equity loan is repaid from a spouse’s salary.
  • Funds already spent on business expenses related to the project that the loan is funding when these can be appropriately documented.

    Let’s look at an example. Your business has been in operation for several months, and you’re applying for funds for inventory and equipment. You’ve already spent money on those needs that’s equal to your equity requirement and have the receipts to document it. This may be eligible toward your SBA 7(a) owner equity injection requirement.

    Be prepared to show where the funds came from to purchase those items, like from your personal savings or your business revenue.

  • A note of standby debt: This is acceptable if you’re acquiring an existing business and the note would come from the seller. This means that they’ll provide a loan to cover up to half (typically 5%) of the equity injection requirement. The SBA won’t allow this loan to be repaid (principal or interest) to the seller until the SBA loan is repaid in full (documentation of this agreement must be included with the loan).

    A seller can also provide financing for a portion of the equity above and beyond the 10% requirement and the borrower could repay this financing. Full standby is required when the seller note will make up part of the required 10% of the required equity. Let’s look at two scenarios as an example:

    • Scenario 1: Let’s say you had a $100,000 project to acquire a business. Ten percent equity on this project would be $10,000. The SBA would permit up to $5,000 (or 5%) to be covered by a fully subordinated note. This means that you would need to come to the table with the remaining $5,000. Overall, the seller could not provide the full 10% if you’re not injecting any funds. Per the SBA, the borrower must fund at least 5% of the project for SBA 7(a).

    • Scenario 2: In a $100,000 project to acquire a business, you have the full $10,000 available for the equity injection. The seller is also willing to hold a note for $10,000. This is attractive to lenders because it would lower the loan amount and their ultimate exposure.

      Since you’re already injecting 10% into the project, it would be up to the lender what the subordination requirements would be on the seller’s note. The lender could allow principal and interest (P&I) payments, interest-only payments, or fully subordinate the debt with no payments allowed. This usually depends on the strength of your business’s cash flow.

  • Assets other than cash: Sometimes, you might have property or equipment to use toward the equity requirement. In this case, an appraisal or other valuation by an independent third party is required if the valuation is greater than the net book value.

What doesn’t meet the SBA 7(a) owner equity injection requirements?

The SBA has a few particular types of funds that can’t be used as owner equity. These include:

  • Funds that are borrowed and repaid from your business’s cash flow.
  • Funds that are paid out of your owner’s salary.
  • The value or cost of education, even if that expense is directly related to your new or expanding business.

How do I document that owner equity was spent on my business?

Many lenders, including Pursuit, require that the equity is spent on appropriate business expenses before the loan closes. Be sure that you hold onto the documents you’ll need, such as invoices paid, receipts for purchases, checks used for payment and/or quotes for higher-cost items, such as equipment.

What types of spending wouldn’t count towards my equity injection? 

The SBA requires a paper trail for payments and of course, it’s a wise business practice to maintain your documents anyway). For this reason, if you can’t produce original receipts, invoices, or quotes for payments made, then these won’t count toward your equity injection.

Why do I have to provide bank statements?

Lenders and the SBA need to ensure that equity funds comply with SBA requirements. In addition, the SBA requires that funds are in your business account for at least three months before the loan closes. This gives them a level of assurance that the funds haven’t been obtained in a way that may not meet SBA requirements and that you’re able to sustain a certain level of financial stability for repayment of the loan.

Additional notes on SBA 7(a) owner equity injection requirements

One of the first things you should do when you start or acquire a business is set up a dedicated business bank account. Simpler is better, too – for most businesses, a single checking account can cover your needs.

After the account is opened, transfer funds into it regularly from a source that can be documented through your bank statements. If your business is just starting out (or you haven’t acquired it yet), the source will likely be money from your personal accounts, such as personal savings, a home equity loan, or a line of credit.

You’ll also want to establish a three-month business-bank-account history before you apply for a loan. Your commercial banker may be willing to extend some form of credit, such as a line of credit or a credit card, to help you cover short-term expenses.

Wherever you are in the loan process, Pursuit is here for you

A loan approval is the best reward for your attention to detail and many Pursuit clients say that the SBA loan process helps them strengthen their financial-management processes, too. Pursuit business advisors are here to help, so contact us today if you need additional information.

Give your business a boost!

Unlock insights, guides, and more when you subscribe to The Goal Getter!

By clicking "Subscribe" you agree to our terms and conditions.

Related articles

Find flexible, affordable business loan options

You are about to leave the Pursuit website

Pursuit provides links from this website to other websites for your information only. Pursuit does not recommend or endorse any product or service appearing on these third party sites, and disclaims all liability in connection with such products or services. We are not responsible for the privacy practices, security, confidentiality or the content of any website other than our own. Pursuit does not represent members or third parties should the two enter into an online transaction, and recommends that you appropriately investigate any products or services prior to purchase. Questions as appropriate to the content should be directed to the site owners.