When owners are in a cash crunch, they turn to fast money to cover it. That quick cash often comes with steep costs: sky-high interest rates and unreasonably difficult repayment terms. It’s a hard and painful way to do business, and it can put the business’s finances at risk. But refinance that quick cash with an SBA 7(a) loan and you can roll it all up into one loan. Here is how that works, step by step.
Debts Aren’t Reasonable
Step one in getting to the heart of your debt problem is figuring out which debts aren’t reasonable in the first place. Write down all of your existing debt payments. Include the lender, the amount owed, the interest rate, the monthly payment, and the length of the loan. As for what counts as unreasonable, the SBA says it depends on the lender’s opinion. Exceptionally high interest rates, weekly or daily payments, or other unusual demands that make the loan difficult to repay usually count. Sometimes refinancing your business debt makes sense for you and the lender, especially as part of a larger deal.
Step two is making sure the debt meets the basic eligibility criteria. The money can’t have been used for anything other than the business. You can’t refinance debt that is already on “reasonable terms,” and you can’t use an SBA loan to simply move a potential loss from your business to the SBA. The original use of the money must have been SBA-eligible when you first got it, unless the reason it was ineligible no longer applies.
If the debt you want to refinance was already a refinance of a prior debt, the current loan needs to be on your books for two full tax cycles before you can apply for an SBA 7(a), and you’ll have to document the earlier notes and show every dollar went to an eligible business purpose. Special rules kick in if you’re refinancing an existing SBA loan or debt with the same lender.
The third piece is that the debt needs to meet at least one of eight categories set by the SBA. The first four of those are that the debt is structured with a demand note or a balloon payment, the interest rate on the debt is above the SBA maximum rates for the loan size and term, the debt is on a business credit card, or the debt is over-collateralized relative to what the SBA would demand. The other four categories include a situation where you have a revolving line of credit but the original lender isn’t renewing it (or you’re restructuring it to get a better rate or term), or the debt’s maturity is not a good fit for what you used it for (compared with the SBA’s maximum maturity for that use of proceeds), or the debt was used to finance a change in ownership of an ongoing business, or any other debt where the lender no longer works for you - which is totally at the lender’s discretion, and there’s an SBA eligibility review to do at that point.
Step four: the numbers have to add up. Depending on which Category you were in, you’ll need to show that the refinance will improve your cash flow by at least 10 percent. Also, the new loan needs to be secured with at least the same collateral and at the same lien priority as your current one, though you can switch collateral as long as it is comparable in value and useful life. And you’ll have to convince the lender that the restructure is necessary and will improve your operations.
Step five: collect paperwork. Before you close, make sure you have all the original loan approval documents for the lender to review. Prior to closing and funding, you will need to request a formal payoff letter to fund that portion of the loan. The lender may also request additional due diligence documents depending on the specifics of the refinance.
Refinance Personal Debt
You can refinance personal debt you used for the business, but there are some details and paperwork involved. The two most common types of debt to do this with are a home equity line of credit (HELOC) or personal credit cards. With home equity debt, you and the lender have to agree and certify that the amount being refinanced was used entirely for business purposes, and you must present documentation to prove that. For a balance on a personal credit card, if you apply for an SBA loan, the lender has to ask you to tie each transaction to a specific business expense. You will also need to certify and document that you will only use the new loan for refinancing business expenses, and the lender will want to see your credit card statements along with copies of receipts for any business expense over $500.
There are a few special cases worth knowing about. If you move all your banking to another institution, and that institution refinances your debt - which could be a bunch of loans including an SBA loan - into a new SBA loan, it’ll be reviewed case by case and the SBA typically won’t approve it. The original SBA loan had already been approved on reasonable terms for the maximum term; in order for a new SBA loan to be approved, the new lender would have to show why the current debt no longer met your needs, and the new lender taking over all your banking generally isn’t considered a legitimate reason. If you bought a business with seller financing and there’s a “balloon” payment coming due, you can still use an SBA refinance to pay it off: as long as the note has been on the business’s books and you’ve been making both principal and interest payments for 24 months or more, and as long as it wasn’t on standby (no payments) during that 24-month period. And about the equity injection: the lender has the final say, but debt refinance transactions typically don’t require one unless you’re doing a bigger project.
SBA 7(a) Refinance
For example, James started his own business building a proprietary piece of furniture that has a pending patent. He raised money to launch his company by selling the product on Kickstarter and also raising some high-interest debt. That was enough to develop his furniture, find a vendor and buy some initial inventory. About a year later, demand is strong and James finds that he can’t keep up with the orders placed with him.
James knew he was a pretty good candidate for an SBA loan because he has operations listed on his financials and proven demand. His local SBDC office connected him with an SBA lender in town. He had asked for $100,000, mostly for inventory and a little working capital, but when the lender noticed the high-interest debt on the balance sheet that would be draining his cash flow for months and years he recommended raising his request to $150,000 total to include refinancing that debt. The original loan’s interest rate was 15.99 percent, as the signed loan documents showed. This meant the new loan was “SBA eligible,” because the old rate was well above SBA’s maximum. James ended up with the money needed to fill 300 new orders. He saves $11,000 per year by refinancing that high-cost debt.
With an SBA 7(a) refinance, under the right circumstances a small business can make its financial house much more habitable. And here’s the proper order of steps: Sit down with your debts and notice where the terms are less than fair, compare your situation against the eligibility guidelines and the eight listed categories, do some number crunching, assemble your paperwork, and then visit with a lender to explore what’s actually possible in your case.
