What is the SBA Loan Equity Injection?
Small Business Administration (SBA) loan equity injection is front money, typically 10% of the loan amount, provided by the borrowers in order to secure SBA 7(a) loans or SBA 504 loans. The SBA’s Standard Operating Procedure document, referred to as SOP 50 10 5(J), outlines guidance for lenders to determine the suitable equity injection.
While applying for business loans or securing investments, lenders and investors require the borrower to commit a worthwhile amount of money to acquirement as “skin in the game” to persuade lenders to lend you money, since you can easily afford the loan payments and is committed to your business. Bringing more skin in the game signifies that you’re confident in your business future and ready to face the failure, in case you default. This equity injection applies to both SBA loans and traditional loans.
The equity injection amount is typically 10%, and 15% for loans involving special or limited use properties. Putting money upfront for can be tough, so prior understanding about SBA loan equity injection will help you getting prepare for the loan application. Here is everything you need to know about SBA loan equity injection along with some other business loan options in case you don’t qualify for SBA loans.
How does SBA Loan Equity Injection work?
While purchasing a home, you probably had to make a down payment. The requirements for SBA loan equity injection are the same. While applying for SBA loans, the bank or lender won’t fund you full amount. They want you to bring in your own resources as a down payment to demonstrate you can afford and are committed.
SBA Loan Equity Injection Requirements
- For startups – An amount of at least 10% is required of the total project cost
- For Complete Acquisitions – An amount of at least 10% is required of the total project cost for change of ownership (15% for loans involving special or limited use properties).
- For Partner Buyout – An amount of at least 10% is required of the total assets after the change of ownership. Alternatively, the remaining owner(s) must provide an additional equity injection of at least 10% of the net worth with maximum pro forma debt-to-worth ratio of 9:1. This option is interesting in cases where the business has adequate equity to secure funds to pay out a minority partner. In such cases, the SBA can lend up to 100% of the total amount.
Equity Injection Down Payment & Sources
A 10% standard equity injection is required for SBA loans that are low in comparison with traditional loans, which usually take up a 20% to 40% down payment. This percentage is the SBA standard but it can vary based on the lender discretion.
In certain cases, SBA 504 loans have higher administered down payments. Startups under two years of time in business and special use properties (hospitals and golf courses) are required to provide 15% of equity injection. If you’re a startup business with special use of properties, you’re required to provide a 20% down payment.
There is a takeaway: the SBA loan equity injection doesn’t necessarily have to be cash down payment—it can come from other sources as well, including:
- Funds from a business bank account
- A personal loan that is not related to business
- Valued business assets you’ve owned for at least two years
- Cash from 401(k) or other retirement accounts
- Seller’s note considering it’s a substitute all over the SBA loan term
Combining Sources of Equity
There is also a flexibility of combining sources for an equity injection. The aptitude to fulfill the SBA equity contribution is more compound than needing to have cash. The equity injection can be anything from an owned property to loans from loved ones, or seller financing. Using a combination of these equity injection sources can help you qualify for SBA and other types of loans that require owner equity.
What Source Doesn’t Qualify for Equity Injection?
In order to bring in your own resources on the table for the SBA loan equity injection, SBA offers flexibility regarding equity injection sources. This is a great deal especially for startups when cash is tight and you have to follow the budget. Having said that, there are some restrictions dictated by the SBA. There are certain sources that don’t qualify for your SBA loan equity injection, including:
- Unvalued assets
- Loans that are not on full standby
- A loan that is used for business cash flow
- Value or cost of education
- Owner’s salary
- Personal stocks or investments
For every SBA loan, the lender will require you to validate and document your equity injection.
Business Loans Alternatives to SBA Loan Equity Injection
For many businesses, providing a sizeable amount of down payment is difficult, especially when you’re just launching your business. Having extra money to spare is even difficult for more established businesses. There are plenty of business loan alternatives to choose from when you can’t afford equity injection. However, the terms on such alternatives will not be as flexible and attractive as you’d get on SBA loans, but there’s no down payment requirement, of course.
- SBA Loan Types
Among many SBA loan programs for businesses, some don’t require an equity injection. In the case of SBA 7(a) loans, an equity injection is required only for startups and changes in ownership. But, if you’re an established business in need of quick working capital, there’s no requirement of a down payment.
Many nonprofit lenders provide SBA Microloans that also don’t require a down payment. With easier requirements than banks, microloans are a prefect-funding option especially for startups and businesses that require smaller loan amounts of $50,000 or less.
SBA Express loan is another option with cash under $350,000 that close significantly faster (within 36 hours) than other types of SBA financing with easier paperwork requirements.
- Alternative Lending
Alternative lending is another no-down-payment option for small business owners. These online loans are generally short-term loans or medium-term loans from non-bank lenders. There is no equity injection requirement, but the loan extension is based on a business’s cash flow.
Online loans are costly as compared to SBA loans in terms of high-interest rates and fees. So, ensure you review and compare the options before choosing an online lender.
- Equipment Financing
Most borrowers that require SBA financing are looking to buy new or used equipment. Rather than an SBA loan, equipment financing is a better option with quick and easy qualifications. You will find a magnitude to equipment financing and leasing companies, which provide funding to different types of industries.
Most equipment financing companies offer 100% financing, however, some might ask for a down payment based on the borrower’s creditworthiness and equipment value.
- Line of Credit
A line of credit is a flexible financing option with no down payment requirement. A credit line allows you a fixed loan amount that you can withdraw as and when needed. The best thing about a line of credit is that you only pay interest on the used funds. Once you repay the drawn amount from your credit line, that amount is again available for you to borrow.
Many online lenders and banks provide a line of credit without any need for a down payment. However, a credit limit is granted based on your business’s revenues.
- Invoice Financing
Invoice financing is another versatile financing option for B2B businesses in need of working capital. With invoice financing, you sell your invoices at a discount to a factoring company in exchange for working capital. It’s a provisional cash flow solution, which allows you to pay for business expenses until you get paid from your customers.
While choosing invoice financing, be cautious since it’s more costly than an SBA loan.
The Bottom Line
Eventually, the SBA loan equity injection demonstrates your commitment and willingness to bring in your own resources to the table as a down payment. Luckily, the SBA also offers flexibility for how you bring forth the down payment essential for SBA loan qualification. SBA loans have the most favorable terms and benefits that can help your business grows, so use that flexibility to your advantage.
Has your small business ever secured an SBA loan? How it helps your business grow? Would you recommend it to other businesses? Let us know in the comments below!