The Small Business Administration has removed the $5 million per borrower cap from the popular 7(a) loan guarantee program. But to take advantage of change, you need to diversify.
Brandon Kochkodin, Forbes Staff
The golden ticket to acquiring a small business has always been a Small Business Administration 7(a) loan. But thanks to a recent and overlooked rule change, the system is getting even better, giving ambitious entrepreneurs the chance to build a diverse conglomerate of small businesses: their own baby, Berkshire Hathaways. was given.
The 7(a) program was established in 1953 under the same law that created the Small Business Administration (SBA). The SBA provides a 75% guarantee on these loans, reducing risk for lenders and encouraging funding to small businesses. That money can be used for working capital, equipment, real estate, and even business acquisitions.
The SBA 7(a) program is preferred by business buyers because it not only gives them access to more loans, but also reduces collateral requirements. In most cases, a personal guarantee from the buyer is sufficient. Even better, borrowers often don’t even have to come up with a down payment. Repayment terms can extend up to 25 years, making it a more affordable option than standard bank loans, which are typically limited to up to 10 years. This program was clearly a success. In fiscal year 2024, 70,242 loans were approved, totaling $31.1 billion, with an average loan size of $443,097.
The total amount of loans issued now is likely to skyrocket. This is because in May 2023, the SBA significantly changed the $5 million cap on total loan guarantees per business owner. Previously, SBA-backed loan borrowers were limited to $5 million, whether across a single business or multiple businesses. But the authorities have updated the “affiliation rules,” allowing borrowers to borrow up to $5 million per company, as long as each company falls into a different subsector of the North American Industry Classification System (NAICS). . With 96 sub-sectors now available, this change opens the door for business owners with good credit and a strong track record to expand and diversify their business scope.
SBA officials said the change was made to “reflect the Small Business Act’s definition of a small business, which states that a small business is independently owned and operated and is not dominant in its field of operations.” . Before this rule change, the SBA treated all companies with shared ownership, regardless of industry, as part of the same “line of business.” SBA officials say, for example, if someone owns a dry cleaning store, a restaurant or a dental office, all of those will be combined to determine the total loan amount.
While this change may have brought the SBA’s lending standards more in line with the Small Business Act, it was still a dramatic move given that the SBA has been grouping businesses together under common ownership for 70 years.
The timing and reasons for this adjustment are open to speculation. One financier suggests this may be partly about optics. Ray Drew, managing director of Winston-Salem, North Carolina-based Truiant Federal Credit Union and host of the podcast “The Art of SBA Lending,” said the SBA has It points out that it encourages lenders to issue small loans to encourage business creation in underserved communities. . (The average loan size has declined 18% since fiscal year 2022.) Meanwhile, the $5 million loan cap has remained unchanged since October 2010, when Congress raised it from $2 million in the Small Business Jobs Act of 2010. Adjusted for inflation, that $5 million cap is now $7.2 million. )
However, the SBA has not asked Congress to raise the cap. “There’s a lot of attention in Washington, D.C., on small loans,” says Drew, 35. “I think they don’t want it to seem like they’re helping a bigger player.” So changing the way the affiliation rules work is a smart workaround, without interfering with the perspective of helping the little guy. It’s a way to funnel more money to successful entrepreneurs, he suggests.
SBA officials say that’s not the case. The rule change comes after more than a decade of consultations with borrowers and lenders. What the agency learned was that the old policy was “too cumbersome, too confusing and too subjective,” officials said. The new rules simplify the definition of affiliation while maintaining “protections to prevent large businesses from pursuing SBA loans.”
This change surprised small business lenders and funding agents, who were initially unsure if it was true or how it would work. Truliant’s Ray Drew didn’t really believe this either, until he was approved for a loan to one of his customers, and the borrower exceeded the previous limit of $5 million.
“You’ve heard it before, but in the SBA business, you hear a lot of different things,” says Stephen Speer, founder of eCommerce Lending, an online business acquisition advisor. “We’ve heard about mermaids and unicorns all our lives, but we’ve never actually seen them. We were definitely skeptical.”
Spear, a 30-year veteran of the small business industry, said he has a client who just a few months ago closed on a $3.8 million loan to acquire a retail floor tile business. A month after that deal closed, the same client wanted to borrow an additional $3.4 million through the 7(a) program to acquire an online skin care company. He said he contacted nine other financing partners to try to close the deal, but Drew was the only one who said it was possible. “Ray” [Drew] They grabbed the corner and took out additional financing,” Speer said. “My client currently has $7.2 million in loans from the SBA in two separate loans.”
Speer, like others in the small business world, is pleased with the rule change. He points out that more people are looking to buy rather than start a business, and more buyers are interested in acquiring multiple businesses. While he, like others, hopes the $5 million loan limit will eventually be increased, he sees the change as a positive step that has come at the right time. As Speer says, “All the businesses that 70-year-olds own are looking to sell rather than pass it on to their children.”
That doesn’t mean everyone thinks the changes are perfect. Eric Pacifici, founder of SMB Law Group, which has advised on more than $1 billion in small business transactions since its founding in 2022, points to the strange incentive structure created by the rule. “We encourage people to diversify,” Pacifici said, adding that diversification, which is fundamental to successful investing, may not be the best approach when actually running multiple small businesses. . That said, some deals have already been concluded, and many clients have asked about the new rules.
Just because borrowers can now exceed the limit doesn’t mean banks will give out $1 million loans to everyone, cautions Triant’s Drew. To qualify for loans totaling more than $5 million, potential borrowers must have excellent credit and a proven track record of success. After all, banks still retain 25% of the risk on these loans.
“If you want to get five $5 million loans from the SBA, you better be very financially strong,” Drew says. “The average Joe won’t get all of that approved.”
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