What Small Business Owners Should Know About SBA Loan Guaranties & Guarantors
What Small Business Owners Should Know About SBA Loan Guaranties & Guarantors
Understanding loan guaranties is crucial for small business owners, as they are key components of securing financing. Sometimes, bank requirements for guaranties can catch applicants off guard, especially if they weren't anticipating this requirement. This article outlines essential information regarding SBA loan guaranties tailored for small business owners. It's worth noting that loan defaults on bank loans are quite rare. Most defaults involve loans under $150,000, with only a handful of loans exceeding $350,000 defaulting in the last 25 years. With this context, let’s dive into the details.
Loan Guaranty Overview
Loan Guaranty: Every SBA loan requires at least one guarantor, whether that’s an individual or a corporate entity. If no individual or entity holds a minimum of 20% ownership in the applicant business, at least one owner must provide a full, unconditional guarantee.
Individual Guarantees: Owners with a 20% or greater stake in the business are required to provide a full, unrestricted guarantee. If the ownership is held by a corporation, partnership, or another legal entity, full disclosure of every individual’s ownership interest is necessary. Depending on creditworthiness or other relevant factors, additional individuals or entities may be asked to provide full or limited guarantees, regardless of their ownership percentages. All loan guarantors must submit a personal financial statement, except for 7(a) loans and 504 projects under $500,000.
Spousal Guarantee: If a spouse owns less than 20% of the business, a full personal guarantee is still necessary if the combined ownership of both spouses and their minor children reaches or exceeds 20%. Non-owner spouses must sign relevant collateral documents. The spouse’s guarantee, secured by jointly held collateral, will be limited to their interest in that collateral.
Corporate, Trust, & Other Guarantees: Entities owning at least 20% of the business must provide a full, unrestricted guarantee. If the owner is a trust (revocable or irrevocable), the trust must guarantee the loan with the trustee signing on behalf of the trust and providing the necessary certifications. If the trust is revocable, the Trustor must also guarantee the loan.
Change of Ownership: Individuals who were subject to guarantee requirements six months before the loan application must still comply, even if they’ve reduced their ownership to below 20%. The only exception is if they have fully divested their interest prior to the application date. Complete divestiture means relinquishing all ownership stakes and severing all ties with the applicant business (including any related Eligible Passive Companies), including employment.
Supplemental Guarantor: This refers to a person or entity that a lender requires to provide a guarantee for prudential reasons, though it is not mandated by the SBA.
Can an Owner Reduce Equity to Avoid Guaranty? Even if an individual has reduced their ownership stake to below 20%, they must still comply with guaranty requirements if they were subject to these requirements six months prior to the loan application date. The only exception applies if they have completely divested their interest before the application date, which entails relinquishing all ownership and severing all ties with the applicant business.
Understanding these aspects of SBA loan guaranties can empower small business owners to navigate the lending landscape more effectively.
Partnership Guaranties
Partner Guarantor: All partners and entities with a minimum 20% ownership in an applicant entity are required to provide a full, unrestricted guarantee.
Added Guarantor on Buy-in Loan: All partners and entities with a minimum 20% ownership in the entity after selling a portion of the equity and that portion being financed by an SBA loan, will be required to provide a full, unrestricted guarantee and be subject to guarantor requirements for the incoming junior partner’s loan. For convention loans for partial equity buy-ins this is typically handled through a grantor agreement and/or corporate guaranty rather than personal guaranties. In these cases an additional agreement or adjustments to the partnership agreement are made protecting the additional guarantors by being able to clawback equity in the scenario of a loan default.
Spousal Guaranty Requirements for SBA Loans
As a small business owner, it's important to understand the spousal guaranty requirements when applying for SBA loans. The new SBA Standard Operating Procedure (SOP) has expanded the circumstances in which a spouse may need to step in as a guarantor. Here’s what you need to know:
Spousal Guaranty Rule: If you own a business and your spouse owns any percentage of it, and together your equity equals 20% or more, your spouse will need to act as a guarantor. For example, if you hold 19% equity and your spouse holds 1%, both of you must guarantee the loan.
Community Property or Spousal Interest in Property: If your spouse has a community property interest in any assets pledged to secure an SBA loan, they may be required to guarantee the loan. This is due to community property laws that grant spouses equal ownership in property acquired during marriage.
Significant Influence Over Business Operations: If your spouse has significant influence over your business, even without direct ownership, they may be required to guarantee the loan. This includes situations where your spouse manages your business finances or makes key decisions, potentially qualifying them as a de facto owner.
Prior Bankruptcy or Credit Issues: If your spouse has a history of bankruptcy or credit issues, the SBA may require their guaranty. The SBA assesses the overall risk of the loan, and a spouse's poor credit history can lead to higher perceived risk, prompting the need for their guaranty.
Limited or No Community Property Laws: In states where community property laws are minimal or absent, spouses might still be required to guarantee loans if they have a significant financial stake in the business or have played a key role in its success. For instance, if your spouse has invested personal funds or contributed valuable skills, the SBA may seek their guaranty.
Borderline Approval Scenario: If your loan application is on the edge of approval, having a spouse who generates income as a guarantor can help secure that approval. This tactic has proven effective in numerous borderline approval cases. SBA lenders can’t directly ask if your spouse can co-sign, but they can inquire about additional guarantors.
Supplemental Guarantor: Updated Definitions: It’s essential to note that a non-owner spouse providing a limited guaranty to secure a lien on jointly owned real estate isn’t classified as a Supplemental Guarantor. This distinction matters because such guaranties are mandatory, while Supplemental Guarantors usually need to meet stricter eligibility criteria and may need to provide a personal financial statement.
Substitution of Personal and/or Corporate Guaranty Liability for Small Business Owners
The SBA introduced a significant change that allows for the substitution of a guarantor. This update is designed to provide greater flexibility for small business owners and franchisees navigating shifts in ownership or personal circumstances.
What You Need to Know About the SBA Loan Substitution Policy: Small business owners now have the opportunity to substitute personal and/or corporate guaranty liability under specific conditions. This adjustment is a game-changer for those facing changes in their business landscape.
Substitution Made Simple: With SBA approval, you can replace existing personal and/or corporate guarantors with qualified substitutes. However, keep in mind that this approval hinges on several factors, such as the good standing of your loan, the financial strength and eligibility of the proposed substitute, and ensuring that the SBA's financial interests remain intact.
Understanding Original Guarantor Liability: It’s important to note that the original guarantor may still be held liable for obligations incurred prior to the approval of the substitution. This protection helps safeguard the SBA's financial interests while allowing you the flexibility to adapt to your evolving business needs.
Key Documents Required for SBA Guaranty:
When substituting a guarantor, be prepared to provide essential documents that any bank will require, specifically outlined by the SBA:
Personal Financial Statements for all owners with 20% or more ownership (including the assets of spouses and minor children) and proposed guarantors.
Business financial statements and/or tax returns, including:
Year-End Balance Sheets for the last three years, with a detailed debt schedule
Year-End Profit & Loss Statements for the last three years
Reconciliation of Net Worth
Interim Balance Sheets
Interim Profit & Loss Statements
Affiliate/Subsidiary financial statements
Pro Tip: If you're in a partnership or have a spouse involved where a personal guaranty is a concern, it’s wise to conduct a pre-check with us. Adjustments often need to be made 6-12 months before applying for an SBA loan, depending on the loan and guarantor type. Navigating multi-partner loans and equity buy-ins for succession planning can get complex, as conventional and SBA lenders have different pros and cons. For more insights, check out our Loanology section on AdvisorBox.
This article is authored by Darin Manis, founder of LoanBox.