Small Business Loan Criteria: Owner Equity Requirements

Business Finance
Small Business Loan Criteria: Owner Equity Requirements

Published: November, 2018

Before going to apply for an SBA loan, consider the criteria that a lender will use to evaluate your loan application.

When applying for a small business loan, do not be surprised to hear your lender discuss “skin in the game.” What does “skin in the game” mean to the lender? It means “investment”, “equity”. Your lender is going to want to know who has it in the transaction you are discussing. By loaning you funds for your small business, your lender will have significant “skin in the game,” or investment in your business. Your lender, however, is not a traditional equity partner. Your lender will not reap the reward from extra profits earned by a very successful business. He will only earn his loan interest and fees; therefore, he wants to make sure your investment is suitable for the risk the lender is taking with your loan. Every loan transaction will have a level of investment, on the part of the business owners, with which the lender finds comfort. Predicting the success of a business, and the resulting satisfactory repayment of a small business loan, is not an exact science.

Every small business lender has its own individual appetite for the types and sizes of loans it wants to fund. By the same token, each lender will find comfort in granting the loan based upon the level of investment made by the borrower. Following are examples of a small business owner’s “skin in the game” which a small business lender would like to see:

Dollar Investment
The lender will compute a debt-to-equity ratio, and compare it to industry averages and other financial benchmarks, to determine if the borrower has adequate skin in the game. Part of that investment includes a measure of the dollars invested in the business by the owner compared to dollars he has received from loans.

Collateral Investment
Even though the lender will look at the borrower’s dollar investment in the business as a measure of contributed equity, the lender will also look at the borrower’s assets offered as collateral for the loan. He may also accept other assets outside the business, pledged as additional collateral, in lieu of more cash contribution.

Seller Investment
Not all small business lenders will accept seller investment to help a buyer of small business assets to qualify for financing. The Small Business Administration rules, however, allow the SBA lender to accept seller standby financing for a portion of the buyer’s qualifying equity. There is a catch. The seller debt needs to “act like” equity. That means the seller will sign an SBA Standby Agreement agreeing to delay requiring payments until the SBA loan is satisfied first. It also means the SBA lender will have first lien rights on the business assets sold by the selling note holder who is permitted to file a second lien on these assets. The standby creditor earns and accrues interest on his loan, but he receives no cash payment until the SBA loan is paid off first.

You are now prepared for responses to your lender’s questions about various small business loan criteria. Happy hunting! May you find the small business loan terms that best match the needs of your business!

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