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    • Cash that’s withdrawn from your retirement account, as long as you can also pay any penalties for early withdrawal.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.