What to Know About SBA Loan Guaranties & Guarantors

What to Know About SBA Loan Guaranties & Guarantors

Guaranties of course are one of the most critical components of a loan and bank requirements can sometimes derail deals when guaranties are required from parties not expecting this or willing to do so. This is a review of what to know for current SBA loan guaranties. I think it is noteworthy to share that loan defaults involving a bank loan are very very low. Almost all loan defaults which have happened are for loans under $150,000 and less than a handful of loans over $350,000 from advisors have defaulted in the last 25 years. Now please continue reading with this context in mind.

Loan Guaranty Overview

Loan Guaranty: Each loan necessitates at least one guarantor, whether individual or corporate. Should there be no individual or entity holding a minimum of 20% ownership in the applicant entity, at least one of the owners is mandated to provide an unconditional, full guarantee.

Individual Guarantees: Owners who hold a 20% or greater stake in an applicant entity are obligated to provide a full, unrestricted guarantee. In cases where the applicant's ownership is vested in a corporate entity, partnership, or any other legal entity, full disclosure of every individual's ownership interest is mandatory. Depending on the credit or other relevant factors, additional individuals or entities might be required to provide full or limited guarantees for the loan, irrespective of their ownership percentages. For all loan guarantors, the LoanBox lender must procure a personal financial statement, with an exception for 7(a) loans and 504 projects less than or equal to $500,000.

Spousal Guarantee: In cases where a spouse owns less than 20% of an applicant entity, a full personal guarantee is mandatory when the combined ownership stake of both spouses and their minor children equates to or exceeds 20%. Non-owner spouses are required to sign the appropriate collateral documents. The guarantee of the spouse, secured by jointly held collateral, will be limited to the spouse's interest in said collateral.

Corporate, Trust, & Other Guarantees: All entities with a minimum 20% ownership in an applicant entity are required to provide a full, unrestricted guarantee. If the owner is a trust (revocable or irrevocable), the trust should guarantee the loan, with the trustee signing the guarantee on behalf of the trust and providing required certifications. If the trust is revocable, the Trustor must also guarantee the loan.

Change of Ownership: Any individual who was subject to the guarantee requirements half a year prior to the date of the loan application is still required to comply with these requirements, even if they have reduced their ownership stake to less than 20%. The only exception applies when the individual has completely divested of their interest before the application date. Complete divestiture involves relinquishing all ownership stakes and severing all relations with the applicant (and any affiliated Eligible Passive Company), including employment (whether paid or unpaid).

Supplemental Guarantor: This is a person or entity mandated by a Lender to provide a guarantee due to prudence and is not required by the SBA.

Can an Owner Reduce Equity to Avoid Guaranty? Any individual who was subject to the guarantee requirements half a year prior to the date of the loan application is still required to comply with these requirements, even if they have reduced their ownership stake to less than 20%. The only exception applies when the individual has completely divested of their interest before the application date. Complete divestiture involves relinquishing all ownership stakes and severing all relations with the applicant (and any affiliated Eligible Passive Company), including employment (whether paid or unpaid).

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

The new SBA SOP has broadened the scenarios under which a spouse may be required to act as a guarantor. Here are some examples:

Spousal Guaranty Rule: For SBA loans, if a spouse of an owner owns any percentage, and the spouse's equity and the owner's equity combined equals 20% or more, the spouse also has to be a guarantor. So, if an owner has 19% equity and their spouse has 1% equity then both must be guarantors.

Community Property or Spousal Interest in Property: If a spouse has a community property or spousal interest in property that is pledged to secure an SBA loan, they may need to guarantee the loan. This requirement is due to community property laws which give spouses an equal ownership interest in property acquired during marriage and spousal interests that allow spouses to inherit property from each other.

Significant Influence Over Business Operations: A spouse may be required to be a guarantor if they exert significant influence over the business's operations, even without a direct ownership interest in the business. For instance, if the spouse manages the business's finances or makes major decisions for the business, the SBA may consider them a de facto owner and require a guaranty.

Prior Bankruptcy or Credit Issues: If the spouse has a history of bankruptcy or credit problems, the SBA may require a guaranty. This is because SBA considers a spouse's creditworthiness when evaluating the overall risk of the loan. If the spouse's credit history indicates higher risk of default, the SBA may require their guaranty to mitigate that risk.

Limited or No Community Property Laws: In certain states with limited or no community property laws, spouses may still be required to be guarantors if they have a significant financial interest in the business or have contributed to the business's success in some way. For example, if a spouse has invested personal funds into the business or provided valuable labor or expertise, the SBA may require their guaranty.

Borderline Approval Scenario: For less established borrowers whose loan is borderline for approval, a spouse who generates income can be added as a guarantor to help push the loan over the approval line with the lender. We’ve used this scenario in several boarder-line approvals to get the loan approved and funded. For SBA lenders they can’t specifically ask you if your spouse can co-sign if the spouse isn’t an applicant. They can ask if there are any other additional guarantors.

Supplemental Guarantor: Updated Definitions: Added language indicates that a non-owner spouse required to provide a limited guaranty to secure a lien on jointly owned personal real estate is not a Supplemental Guarantor. This clarification is important as such a guaranty is mandatory, and Supplemental Guarantors are typically only required for voluntary guarantees. For instance, if a business owner is obtaining an SBA loan to finance the purchase of a portion of their business partner's ownership stake, and the business owner's spouse is required to provide a limited guaranty to secure a lien on the couple's jointly owned home, the spouse is not considered a Supplemental Guarantor. The key distinction is that the Supplemental Guarantors are typically subject to stricter eligibility requirements and may be required to provide a personal financial statement.

Substitution of Personal and/or Corporate Guaranty Liability

The SBA added the ability to substitute a guarantor.

SBA loan substitution policy: Borrowers now have the ability to substitute personal and/or corporate guaranty liability under certain conditions. This change offers greater flexibility for small business owners and franchise owners facing changes in business ownership or personal circumstances.

Substitution Allowed: With SBA approval, borrowers can now replace existing personal and/or corporate guarantors with qualified substitutes. Approval for substitution is contingent on several factors, including the good standing of the loan, the financial strength and eligibility of the proposed substitute guarantor, and the absence of adverse impact on the SBA's financial interests.

Original Guarantor Liability: The original guarantor may still be liable for certain obligations incurred before the substitution is approved. This ensures that the SBA's financial interests are protected while providing borrowers with an option to adapt to evolving business needs.

SBA Guaranty Documents Include:

These are the documents that about any bank is going to require from a guarantor but which is specifically listed by the SBA:

• Personal Financial Statement on all owners of 20% or more (including the assets of the owner’s spouse and any minor children), and proposed guarantors.

• Business financial statements and/or tax returns. Documents include:

• Year End Balance Sheet for the last three years, including detailed debt schedule

• Year End Profit & Loss Statements for the last three years

• Reconciliation of Net Worth

• Interim Balance Sheet

• Interim Profit & Loss Statements

• Affiliate/Subsidiary financial statement

My advice is if you have a spouse or partnership scenario where a personal guaranty would be an issue that you do a pre-check with us if you are looking to make adjustments in order to remove a person from being a guarantor. For SBA loans there is typically a 6-12 month period (depending on the loan and guarantor type) which changes would need to be made in advance of applying for the loan. For multi-partner loans and equity buy-ins for succession planning purposes it can get complicated with conventional and SBA lenders having completely different set of pros and cons. See our Loanology section on AdvisorBox for more details.