Equity Injection and SBA limitations
December 08, 2022
by a searcher from Vanderbilt University in Denver, CO, USA
Hello Searchfunder! I'm looking to put together a capital stack that will work well with an SBA 7(a) loan, and I'm having difficulty determining what's permissible based on my review of podcasts, interviews, and posts here on searchfunder.
In short, I'm seeing contrasting advice, and I'm hoping I can get a more definitive answer from those with experience in this group.
1. HELOCs: I've seen a lot of advisement saying that it's fine to take out HELOCs and use that equity as part of the capital stack. I've seen others saying the opposite; that the SBA program does not allow equity to be borrowed. Can anyone provide more clarity here? I have significant home equity that I would be happy to tap into, but don't want to break any rules that could blow up a deal under LOI. Perhaps the HELOC must have been drawn X days in advance of the SBA loan closing?
2. Family & Friends: If taking money from family and friends, are there any terms for the incoming funds that must be met? e.g. must they be gifts? Can they be loans? Or must they be structured as investments with a return? Any other considerations there?
3. While I'm asking, are there other sources of capital that are commonly tapped into (aside from liquid stocks/cash) that are SBA-permissible? I've heard of plundering 401ks, but for security purposes, I'd rather leave those funds in place. Anything else to consider?
Appreciate any guidance you can provide.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
1) Home equity loans can be used so long as there is outside income to make those payments. When they say borrowed funds, you cannot advance on a credit card, get some sort of unsecured loan, or borrow money from a family member to put down on the purchase. The SBA will look at roughly 90 days of account statements to verify liquidity prior to closing. If any large deposits come in within those preceding 90 days, they will want to source those deposits going back 60 days. So if any of those funds come from borrowed sources, outside of a home equity loan, it likely will not work.
2) Friends and Family can get involved in multiple ways. First, they can give you the funds as a gift so long as they come with a gift letter. However, most lenders will only allow gifts from family and not from friends. They can also invest in the transaction. However, if they end up with an ownership interest that is 20% or more, then they will be required to guarantee the loan. However, their percentage of the equity invested does not need to match their ownership interest. A family member could invest 50% of the equity and only end up with a 5% ownership interest. The primary owner who is signing the personal guarantee and required to operate the business is taking on other risks in lieu of putting up equity. What you cannot do with the investment is have it be in the form of debt. Also, there cannot be any mandatory repayments while the SBA loan is in place of equity contributions typically.
3) Borrowers will use a self-directed IRA or ROBS account to acquire the business or a portion of the business. I am not an expert on all of the rules related to this, but in essence you own part of the business in your retirement account. It has tax consequences on a different level and can limit the return of profits to the owner. But it is a method to buy a business and take advantage of large retirement funds.
If you would like to discuss these or other items in more detail, please do not hesitate to reach out to me at any time at redacted Have a great day!
from The University of Alabama in Birmingham, AL, USA
2. friends and family can come in as investors (sub 20% they don’t guaranty) or they can provide a gift letter. Loans won’t work here except under the same guidelines as 1. And investors cannot have any sort of guaranteed payments that would make their investment look like a loan.
3. Loan from a retirement account follows the same stipulations mentioned. Liquidating retirement is fine if you’re comfortable with it. RoBs program is used quite often here as well. Essentially a penalty free investment from your retirement account into a corporation you own.