Disaster Loan or 7(a) Loan Program: Why not both?

A photo depicting documents used to file for a small business loan during the 2020 COVID-19 pandemic, taken in Atlanta, GA.
An update on U.S. Small Business Administration loan options for small businesses impacted by COVID-19

Last Friday, we published an analysis of both the SBA Disaster Loans and the proposed amendments to the SBA 7(a) Loan Program. Late last night, the Senate passed the CARES Act, a stimulus bill aimed at injecting liquidity into the U.S. economy in the face of the COVID-19 Crisis. The CARES Act is forecasted to pass the House of Representatives overwhelmingly tomorrow and the President’s signature is expected to follow in quick succession.  

While the basic framework of the draft bill we previously reviewed remains intact with respect to the SBA Disaster Loans and 7(a) Loan Program amendments, coverage has been significantly expanded. Additionally, some key provisions have been changed in ways that will have a material impact on small businesses looking to borrow under these programs. Oh, and it has a fun new name – the Keeping American Workers Paid and Employed Act. 

One thing that has not changed is the purpose: Encourage small businesses to preserve jobs. 

As always, our information is as accurate as possible at the time of publication. The following analysis of the SBA Disaster Relief Loans and the enhanced SBA 7(a) Loan Program is based upon the Senate version of the CARES Act. It could be amended in the House. Moreover, the SBA will need to provide lenders with some guidance in relation to underwriting and deployment of capital before the funds can go out to small businesses. 

SBA Disaster Loans 

The previous draft of the CARES Act did not discuss SBA Economic Injury Disaster Loans. Disaster Loans are intended to offset economic damage due to emergency. These low-interest loans are available to businesses located in areas affected by different types of disasters. In the case of COVID-19, it seems the entirety of the United States an affected area. The CARES Act now explicitly discusses Disaster Loans.   

Here’s what remains true from last Friday: 

  • Economic Injury Disaster Loans will be available to any business with 500 or less employees. 
  • Funds received can be used for payroll, rent and mortgage payments, and other “obligations that cannot be met due to revenue losses.” 
  • They are available to any small business which has suffered “substantial economic injury,” which is defined as being unable to (1) meet obligations as they mature, (2) pay ordinary and necessary operating expenses, and (3) market, produce, or provide a service or product ordinarily provided by the business. 
  • Businesses may borrow up to $2 million, but anything over $500,000.00 will require enhanced levels of underwriting. 
  • Credit scores are an eligibility factor, but the scoring minimum is unknown. 
  • The interest rate for for-profit businesses is set at 3.75%. 
  • There is no prepayment penalty. 

Here’s what is different: 

  • The maximum loan amount will be equal to 25% of a business’s Gross Profit, as stated on its most recent federal tax return. Previously, we believed this amount to be 50% of the Gross Profit. 
  • Loans will be subject to up to a 30-year repayment term with the first twelve months deferred with no payments. 
  • Some loans may require the taking of collateral by the SBA. 

Here’s what is new: 

  • Loans of not more than $200,000.00 will not require any personal guaranty. While not explicitly stated, we understand loans of up to $200,000.00 under this program will not require the taking of collateral. 
  • Businesses need not to have been in operation for one year in order to be eligible for the SBA Disaster Loan; all business in operation as of January 31, 2020 are eligible. 
  • Applicants do not need to show that they are unable to obtain credit elsewhere to be eligible. 
  • Small Dollar Loans, which we are told are loans of $350,000.00 or less, can be awarded solely on the basis of credit score and do not require submission of tax returns. 
  • Eligible applicants can be awarded an Emergency Grant of up to $10,000.00 within three days of submitting their application. This grant does not need to be repaid, even if an applicant subsequently is denied an SBA Disaster Loan. 

We are hearing from clients and fellow business owners that the application website is absolutely overwhelmed at all hours. The option to login to the website has been removed and those who have previously submitted an application cannot check their status. Business owners are resorting to submitting applications by mail. 

SBA 7(a) Loans 

The 7(a) Loan Program is the SBA’s primary program for providing financial assistance to small businesses. A 7(a) Loan is typically issued by a bank lender with a guaranty from the SBA. The guaranty is provided to encourage private lenders to make loans to small businesses that might not otherwise qualify for a business loan. 

Under its version of the CARES Act, the Senate has expanded the scale and scope of the 7(a) Loan Program on a massive scale. The typical annual budget for this program is around $30 billion; the program under the CARES Act seeks to deploy $350 billion capital in only a few months. 

Here’s what remained the same from the initial draft bill: 

  • The 7(a) Loan Program is available to almost any business with 500 or fewer employees. 
  • Businesses may borrow up to $10 million. 
  • Funds may be used for payroll support, salaries, mortgage payments, rent payments, utilities, and other debt obligation payments. 
  • Lenders will have greater authority to approve loans without receipt of SBA approval. 
  • All loan fees will be waived to the maximum amount possible. 
  • Payments on all loans will be deferred for not less than one year. 

Here’s what is new: 

  • The definition of payroll has been expanded to include self-employed individuals and certain types of payments made to business owners outside a standard W-2 paycheck. 
  • The maximum loan amount available to borrow will be calculated by multiplying the borrowing business’s average monthly payroll by 2.5, not to exceed $10 million. This is significantly less generous than the draft version, which allowed a maximum amount calculated by multiplying monthly payroll, rent, utilities and other expenses by 4. 
  • The above also factors into the amount loan forgiveness available. Previously, it appeared that business would be able to receive grants covering 4 months of payroll. The new multiplier effectively lowers that to 2.5 months. In order to receive the full grant/debt forgiveness, borrowers will still need to maintain their payrolls at the level they were prior to the COVID-19 Disaster. 
  • There is a carve out for hospitality businesses with more than 500 employees that will allow them to borrow under the program. 
  • Neither a personal guaranty nor the taking of collateral is required for a borrower under the program. Put more simply, the government is lending hundreds of billions of dollars in unsecured loans. This is incredible. 
  • The maximum interest rate is capped at 4%. 

Why not both? 

In the draft bill, borrowers accepting SBA Disaster Relief loans were ineligible for the 7(a) Loan Program, and vice versa. This is no longer the case. Under the Senate version of the CARES Act, businesses are eligible to receive funds under both SBA loan program. Accordingly, we strongly encourage businesses to apply for the Disaster Relief Loan as soon as possible and to prepare to apply immediately for the 7(a) Loan Program once available. The attorneys of Williams Teusink are available to help navigate the application process.  

What we are hearing from SBA lenders

Lenders are flabbergasted. They have equated this program to simply shoveling money out the door as fast as possible. The result will be a fee bonanza. While most SBA lenders make their money selling the debt on the secondary market, this will be practically and fiscally impossible for these loans because of the loan forgiveness provisions of the CARES Act. For this reason, lenders will receive origination fees as follows: 

  • 5% for loans of not more than $350,000.00. 
  • 3% for loans of more than $350,000 and less than $2 million. 
  • 1% for loans over $2 million. 

If we (conservatively) assume a blended rate of 1.75%, lenders will be in line to receive origination fees of more than $6 billion dollars. 

Lenders are gearing up, but they are learning about all this in real time. We expect the SBA is actively working on guidance and regulation for SBA lenders so that these programs can be rolled out quickly once the CARES Act is signed into law. 

What we are hearing from small business 

We have not spoken to a single business that is not interested in these loans. But we have noted vast differences in familiarity with the terms and application progress. Business owners are all over the proverbial map. Some businesses received their Disaster Loans over a week ago. Others are just learning they are eligible.  

Our recommendations 

Apply for the Disaster Loan. Now. Then, get your company’s financials ready for your 7(a) Loan Program application. Now. Documents you should have at the ready include, but are not limited to: (1) tax returns, (2) year-end financial statements, (3) current financial statements, (4) personal financial statements for sole proprietorships and independent contractors, and (5) corporate organization documents. 

Additionally, we must offer this word of warning: we are already hearing reports of individuals looking to capitalize on assisting businesses with these applications. Be wary of anyone promising that you will receive a loan. If you need assistance, your best option is to work with your lawyer or your accountant. If you don’t have a lawyer or accountant, talk with a fellow small business owner you trust about who they use. 

New information is constantly becoming available. The best way to get current information is to contact us directly; our doors are closed, but we are working full time, answering calls, and checking email. Should you have further questions or concerns, please reach out. Williams Teusink will continue to monitor developments and provide updates as things change and, as we all know, they will.