The United States Small Business Administration (“SBA”) oversees two loan programs that are intended to benefit small business owners and promote employment. The programs, known as the 7(a) Loan Program and Section 504 Loan Program, serve different purposes. 7(a) loans are intended to provide funding for short and long-term working capital, for purchases of furniture, fixtures and supplies, and for refinancing of business debt, while 504 loans provide long-term fixed-rate financing for fixed assets with the intent of promoting business growth and job creation. Recently, the SBA changed the rules that apply to both of these loan programs for the purposes of: (a) making loans available to more small businesses; (b) expanding the loans made to minority and underserved communities and businesses; and (c) increasing efficiency in the loan approval process.
Increasing Loan Providers and Adding a New Lender Type
Traditionally, SBA loans have originated from or through a bank or credit union. However, the revised rules aim to increase the number of entities or institutions that can issue loans. The revised rules aim to do this in two ways:
First, the SBA is continuing the Community Advantage (“CA”) loan program. Under the CA program, “community-based, mission-focused lenders [which met] the credit, management, and technical assistance needs of small businesses in underserved markets” [1] were allowed to operate under a pilot plan that was due to expire in 2024. Under the new rules, CA lenders as they currently exist will convert to the new program, and new applicants can seek qualification as a CA lender. Under the pilot program, both nonprofits and for-profit entities could become a CA lender, but the new program is only open to nonprofits. The goal is to provide small businesses with more lenders who can help them access SBA loans, thereby creating a “Community Advantage.”
Second, the rules lift the moratorium on licensing for new Small Business Lending Companies (“SBLC”). While the SBA has historically limited the number of SBLCs to 14 non-depository lenders backed by SBA loan guarantees, this cap has been removed to expand opportunities for small business. By having more entities available to make loans, it is hoped that this will increase access to these loans, particularly for businesses that are currently underserved. Initial projections are that at least three new SBLCs will be licensed by the SBA and this in turn will increase the number of loans by over 400 new loans over the next four years. [2]
New Lending Criteria
Under the existing 7(a) and 504 loan programs, any business applicant had to be evaluated based on a number of factors, including:
- Ability to repay the loan;
- Character and credit history of the business and principals;
- Value of the collateral;
- Business experience of applicant and its principals;
- Review of the equity invested in the applicant;
- Past and future financial statements of the business;
- Analysis of the potential for success by the applicant business; and
- Business strength.
With the change in rules, the factors to be considered are now abbreviated and include credit score/credit history, earnings/cash flow, and the equity and collateral of the applicant. It is believed that the new factors are more objective and will allow for more minority-owned and underserved businesses to obtain loans. Lenders who issue these loans also have to utilize commercially reasonable credit analysis that is comparable to similarly sized non-SBA guaranteed commercial loans; the underwriting of the loans must be done in the same manner as non-SBA guaranteed loans; and lenders must require hazard insurance on loans greater than $500,000 (for 7(a) loans and for projects of 504 loans). The new rules also change who can reconsider any SBA loan denials. Previously, the Director of the Office of Financial Assistance could make that determination, but now the Director can designate others to make the decision.
The new rules will also allow borrowers to utilize 7(a) loan proceeds to fund partial changes in the ownership of the business. In the past, 7(a) loan proceeds could only be utilized for such a purpose if there was a total change in ownership. This will allow borrowers more flexibility to restructure the business.
Finally, the SBA will begin utilizing new technology starting later this year to determine borrower eligibility. The goal is to reduce the burden on SBA lenders and streamline the process so that lending can be increased.
New Fraud Review and Other Procedural Simplifications
As part of a new government goal to reduce fraud, the SBA will implement new technology, new analytics, third-party verification systems, and artificial intelligence tools to conduct fraud review on all loan applications prior to the loans being approved. These new tools will start being used in August 2023. Historically, lenders approved loans without much oversight by the SBA, increasing the potential of fraud. By implementing these new processes, the SBA aims to streamline the application process and protect taxpayer money at the same time. New procedures also will be implemented to avoid duplicative and unnecessary documents and forms for lenders.
Conclusion
These changes introduced by the SBA are intended to make SBA loans more available to small business owners, particularly those in underserved areas and those operated by minorities. The SBA is increasing the number of non-depository lenders who can make SBA loans, revising the lending criteria, allowing 7(a) proceeds to be used for partial changes in organizational structure of the borrower entity, and utilizing new technology, new processes, and increased fraud review to improve their loan programs and increase the number of loan recipients. The SBA’s goals are ambitious; it will be important to see if these rule changes have the impact and effect that the SBA intends to have in the coming years.
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[1] https://www.sba.gov/partners/lenders/7a-loan-program/pilot-loan-programs
[2] https://www.federalregister.gov/documents/2023/04/12/2023-07181/small-business-lending-company-sblc-moratorium-rescission-and-removal-of-the-requirement-for-a-loan