Contrary to popular opinion SBA Loans are quite flexible. Case in point, The SBA Standby Creditor’s Agreement.
This Agreement establishes the interest rate and loan terms of a promissory note between the buyer, referred to as the Standby Borrower and the Seller, referred to as the Standby Creditor, to mitigate three fundamental credit weaknesses in the loan application.
- A Short-Fall in Cash Injection and Post Close Liquidity
SBA 7(a) and 504 loan requests to purchase real estate or acquire a business or franchise require a minimum 10 percent equity injection.
Due to a recent update to SBA guidelines, the 10 percent equity injection may come from a combination of cash from the buyer and a seller promissory note.
For example, of the 10 percent equity injection, at least 5 percent must come in the form of cash from the buyer, while the remaining 5 percent in the form of a seller promissory note on permanent standby.
Permanent standby simply means the seller’s promissory note is not permitted to be paid back until the SBA loan has been paid in full.
The standby loan decreases the amount of capital injected by the borrower, increasing cash reserves post close.
- Collateral Coverage Shortfall
SBA 7(a) loan requests above $350,000 require collateral to be pledged when available.
The actual amount of collateral varies and is determined by the requested loan amount, the amount of collateral available and purpose of the loan.
The definition of acceptable collateral includes but is not limited to equipment, tenant improvements and real property typically in the form of a second lien on the applicants primary residence for working capital term loans to acquire a business or a commercial mortgage for the purpose of purchasing owner-occupied real estate.
Let me illustrate. Buyer A is acquiring a business for $3,000,000. Buyer A is able to inject the minimum 10% required of $300,000 resulting in a loan amount of $2,700,000. Buyer A is willing to pledge their personal residence with $500,000 lendable equity.
The loan amount of $2,700,000 minus the pledged collateral value of $500,000 equals a collateral short-fall of $2,200,000 which is higher than is permissible by the lender.
In this case, the Seller agrees to carry a promissory note in the amount of $700,000 to meet the lender’s acceptable collateral short-fall criteria of $1,500,000.
The seller is able to request repayment of the promissory note during the SBA loan repayment period only if cash flow is acceptable. If not, the lender will require the promissory note to be placed on permanent stand-by as defined previously.
- Cash Flow Shortfall
SBA 7(a) and 504 loan requests are required to meet a minimum debt service coverage ratio set by the SBA. If cash flow to repay the loan is insufficient the seller is able to mitigate the shortfall for the buyer by carrying a promissory on permanent stand-by.
The Standby Creditor’s Agreement consists of two sections. Section 1 is fill-in-the blank establishing the general terms of the promissory note between the buyer and the seller.
Section 2 consists of 8 conditions that must be met by the seller. I will highlight the most important conditions.
- Item number 1 requires the seller to agree to only one of the four options listed; either placing the standby loan on permanent standby or establishing repayment criteria concurrent with the SBA loan that include principal and interest or interest only payments.
- Item number 2 requires the seller to turn over any payments made by the buyer to the Lender in violation of the agreement.
- Item number 5 requires the seller to sign appropriate documentation to subordinate to the Lender’s loan secured interests in collateral that secures the Standby Loan.
- Item number 6 gives the Lender the ability to modify the terms of the agreement without affecting the enforceability of the agreement by the Lender.
The form is completed by the lender and is signed by the Seller who affirms the stated terms and conditions of the agreement.
My SBA Loan Pro
The My SBA Loan Pro Podcast is hosted by Your SBA Loan Pro, Ryan Smith. In each episode Ryan provides valuable information and best practices regarding the SBA loan program.
Each episode is approximately one minute in length and addresses topics related specifically to SBA 7(a) and 504 loan programs to purchase real estate, acquire a business or franchise and obtain working capital.
You’re encouraged to listen and subscribe to ensure you’re notified each time a new episode is available. Ryan publishes a new episode weekly on Tuesday mornings, unless he’s kidnapped to a deserted island of course.
You can listen and subscribe on your favorite platforms including Apple Podcasts, Spotify, Google Podcasts, Anchor and Stitcher.
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