The Science of SBA Loan Approval

Are you a business owner or entrepreneur applying for an SBA loan or planning to in the near future? If your answer is yes, then keep listening because this podcast is for you.

In this podcast I reveal the science of obtaining SBA loan approval. That’s right, being approved for an SBA loan is a science and is based on the following five fundamentals.

The first fundamental is Experience, the second Liquidity, the third Personal Credit History, the fourth Cash Flow and the fifth Credibility.

Fundamental Number 1 – Experience

Satisfactory experience can either be direct or equivalent. Direct experience is self explanatory. An applicant is buying a flower shop and they’ve owned or operated a flower shop in the past.

Equivalent experience is more subjective. I define equivalent experience as experience which has equipped the applicant to succeed in their new venture and may include everything from achieving a post-secondary degree, such as an MBA, to holding a senior management position where the applicant managed a team, prepared budgets and forecasts and was involved in hiring, firing etc.

For example, an applicant is acquiring a commercial pool cleaning service but they’ve never owned a similar business or cleaned a pool in their life. However, they were a senior analyst for a private equity firm and have participated in several mergers and acquisitions and sat on numerous Board of Directors. This qualifies as equivalent experience since the applicant has demonstrated a working knowledge of business accounting, management and marketing.

Fundamental Number 2 – Liquidity

Liquidity refers to business or personal cash balances at the time of loan origination in a checking or money market account. Cash balances can also include cash value of life insurance and non-retirement marketable securities. The general rule is the applicant should possess the minimum 5 – 10% cash injection required by the SBA and a minimum of an additional 5% of the loan amount in cash reserves, though 10% is better.

For example, an applicant is acquiring a business for one million dollars, it’s best they possess a minimum of between one hundred fifty to two hundred thousand dollars at the time of loan origination. Fifty to one hundred thousand dollars to inject between 5 – 10% cash into the business or real estate purchase and one hundred thousand dollars in cash reserves for working capital and personal expenses and debt.

Fundamental Number 3 – Personal Credit History

Personal credit history refers to an applicant’s management of their prior personal debts, not necessarily their credit score, though the SBA does require a minimum credit score of 640 to qualify along with no adverse credit within the previous three years.

Adverse credit includes but is not limited to bankruptcy, foreclosure, short-sale or credit card charge off. The combination of no prior adverse credit and a FICO score above 700 greatly improve the likelihood of loan approval.

Fundamental Number 4 – Cash Flow

Cash Flow can either be in the form of historical cash flow or projected cash flow. Historical cash flow refers to cash flow generated in the businesses three year period preceding the loan application and projected cash flow refers to future cash flow based on credible, substantive financial models.

Either historical or projected cash flow must meet the lenders minimum underwriting criteria to obtain loan approval. Acceptable cash flow is calculated by dividing recurring net operating income by the aggregate of existing plus proposed debt.

Fundamental Number 5 – Credibility

Credibility is material to successfully applying for an SBA loan. I define credibility as possessing the requisite skills to prepare a business plan with financial projections and demonstrate the business acumen to successfully operate the subject business and pay back the loan.

Credibility or lack thereof will be determined by the lender upon review of the loan application and an underwriter phone interview. The underwriter phone interview is a call between the applicant and underwriter where the underwriter asks questions of the applicant regarding the salient points of the loan application.

Conclusion

In conclusion, obtaining SBA Loan approval is highly likely when the loan applicant possesses direct or equivalent experience, meets the SBA’s minimum liquidity requirements, has satisfactory to exemplary personal credit history, is able to demonstrate satisfactory historical or projected income and is a credible applicant.

It is my practice to identify whether prospective applicants possess these five fundamentals in my first interaction with them.

If the applicant lacks one or more of these fundamentals I quickly determine whether there are mitigating factors that would merit a loan approval. If yes, we proceed with the loan application and if not, I will recommend the applicant apply at a later date saving them time, energy and money.