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You know from having been through the SBA loan application and approval process that getting financing from the U.S. Small Business Administration is no small feat. It means you’ve been vetted and given the go-ahead as an elite group of America’s most financially savvy business owners. And, whatever happens, no one can take that away from you. But life, and business, does happen, and some who take out SBA loans do experience SBA loan default.
First, don’t panic. You’re not the first—and certainly won’t be the last—to default on an SBA loan. We’ll go through what happens if you do need to go through the SBA loan default process. Plus, if you’re towing a dangerous line between loan delinquency and default, we’ll let you know how to tell if you’re reaching the SBA loan default point of no return.
As they say, knowledge is power. If at all possible, try to avoid going into SBA loan default in the first place.
The first thing to do is understand where SBA loan delinquency ends and default begins. They have very different consequences.
If you’re delinquent on your SBA loan payments, that means that you’re behind. But your lender hasn’t marked you as entirely unable to pay. When you’re delinquent, you can expect that your lender will assess a late fee (though it will vary depending on whom you’re working with). Although each bank or whichever kind of intermediary lender has a different policy about how they contact delinquent borrowers, expect them to reach out to figure out why you’re late. Probably multiple times, at that.
The good news is that your lender will try to work with you in your situation to get repayment, possibly by restructuring your terms or figuring out another solution. You have a good track record, remember? That’s why you were approved for an SBA loan in the first place! You’ll usually have about 30 days to pay your lender some balance, or come to an arrangement, before your delinquency gets reported to the credit bureaus and you’re flagged as a possible default.
SBA loan default, on the other hand, means that you’ve missed payments for a long period of time—generally because you don’t have the funds to pay back what you owe. (There’s another scenario where you could accidentally go into default, but we’ll skip this for now and touch on it below.)
This is a much tougher spot to be in, compared to merely being behind on payments but eventually getting some amount of payment in, even late. Lenders usually wait about 90 to 120 days before initiating the SBA loan default process, since it’s not fun for anyone. How long before they declare you in default depends on the terms of your contract.
If your business financials aren’t performing the way you anticipated they might when you first took out your SBA loan, you’re necessarily going to have a harder time coming up with the money to make your loan payments. The first place you want to look to be able to tell whether or not you anticipate having the liquidity to pay your lender at any point soon is your cash flow forecasts.
Since your cash flow is the best indicator of your financial health as a business, you should always be keeping an eye on your cash flow. But if you don’t have positive cash flow—or if your projections say you’re not going to be able to make up the ground you’ve lost on your loan payments—you should hear alarm bells going off.
And you should also start a conversation with the initial bank that loaned you the money (not the SBA since, as you know, the government doesn’t lend cash themselves). It’s not a badge of shame to let them know you’re having some trouble with your payments—far from it, in fact. They’d much rather hear from you than chase you down.
As a general rule of thumb for all business loans, not just SBA loans, talk to your lender if you’re having hiccups with paying off your loan. A lender never wants you to be in a position where you can’t pay them back—they are in the literal business of getting back their money, after all—so they’d rather you give them the heads up that your circumstances have changed. That way, they can work with you if possible to augment your repayment structure, have you pay only the interest on your loan for the time being, or at least give you a bit more time.
That’s a win-win for everyone.
Any agreement you make will have to be given a thumbs up by the SBA. But, again, the government doesn’t want you to go into SBA loan default, either.
Circumstances that put you into accidental SBA loan default actually exist—they’re exactly why people use the cliché to “read the fine print.” And they’re very much worth mentioning.
You could have literally perfect credit and pay off every dime of your SBA loan on time. But if you violate a clause in your SBA loan agreement, you could automatically send your loan into default. For instance, if you stack another loan on top of your existing SBA loan or add new shareholders to your company without tipping off the SBA. It’s rare—but it can happen, and you should definitely know about it.
It’s not always possible to catch a boulder rolling down a hill. If you default on your SBA loan, that’s okay. Again, don’t panic—that’s the first, most universal rule. There’s a process to follow. Your best weapon is to know exactly what you’ll be faced with.
If you aren’t able to strike a deal with your lender or you can’t make the finances work by the end of your interest-only payment period, then SBA loan default becomes a reality. You’ll likely get what’s called a Demand Letter, which is a legal notice that means that you’re on the bank’s radar for default. (In other words: Don’t ignore it.)
As you likely know with an SBA loan, the government guarantees a portion of your loan to the intermediary lender—that’s what makes them able to keep their rates so desirable. But although the SBA guarantees up to 85% of your loan, they’re actually the last group that your lender’s going to approach in order to get their money back.
First, as a borrower, lenders will attempt to seize and liquidate any assets you listed as the SBA loan’s collateral. This includes business bank accounts, real estate, machinery, inventory, or equipment—anything that you used to guarantee the debt. Unfortunately, if your business needs to “cease operations”—the SBA’s term to foreclose—to settle debts, you’ll need to do that in lieu of settling loan.
If your lender isn’t able to recoup enough through your business assets, even through the sale of your business (or if you no longer own the items you used as collateral, which is a big don’t), they may come after your personal property. And they can, due to the SBA loan personal guarantee that you almost definitely signed. That gives your lender the right to go after your own assets in order to settle your business debt in situations just like this. The same holds true for any business partner who also signed a guarantee alongside yours.
Because the SBA guarantees quite a bit of your financing to the lender—15% of principal for loans up to $150,000 or 25% for $150,000+—the lender doesn’t have to recoup every penny you borrowed to be satisfied. If they get 75% or 85%, depending on the size of the initial loan, the SBA will subsidize the rest. If you are able to pay up to what your lender needs to recover, them getting the remaining 25% or 15%, respectively, isn’t your problem.
What is your problem, however, is that the government is going to want to try to get as much of that remaining balance back from you as possible. The feds are the ones now out that money. The SBA will begin its debt collection process with a 60-day demand letter. By now the US Treasury Department is in charge of getting the government’s money back, and this demand letter is their way of letting you know that you’ve got 60 days to get the money together before they begin going through your finances.
At this stage, there’s no real way to avoid paying something back if you’ve managed to escape it previously. The Treasury knows what money you have, what money you make, and how much you can devote to paying off your defaulted SBA loan. As frightening as that sounds, the feds would much rather get paid than punish you. (If you think you’re sensing a common theme here, you should.) In many cases, you’ll be able to offer a lump sum payment, which is more common, or work out a repayment plan in some other situations.
If you don’t have any more money to pay at all, you’ll complete a form known as the Offer in Compromise. It’s essentially your last chance to show the SBA (and your lender if you haven’t paid them much, either) that you simply can’t pay—no matter how much you wish you could.
The Offer in Compromise form asks you to detail your finances, including tax returns, personal and business assets, transfers of assets to other people (along with their personal information), income statements, and expenses. You’ll need to show the SBA without a shadow of a doubt that your business has closed (liquidated and no longer in existence), and your personal coffers are empty.
The SBA doesn’t have to accept your offer in compromise. They can reject it, in fact. But if both the lender and the SBA accept your Offer in Compromise, you’ll come to terms on a settlement and a date to pay it. If there’s one thing you take away, it should be this: Pay it on time.
Whatever you do, you don’t want an SBA loan default to get you in legal trouble. Litigation is entirely avoidable—but it’s up to you to be responsible.
Foremost, you have to own up to your default. If you can’t pay, you need to be in touch with your lender and the SBA. Don’t ignore communication like demand letters. Remember that although defaulting on an SBA loan is new and terrifying to you—which is a very justified feeling, of course—this is something that both the federal government and lenders have gone through before. They have a very specific process for it for a reason, which includes documentation and recordkeeping in case they do have to initiate legal action. Which isn’t good news for you.
For instance, if you do ignore communication, the SBA has the legal right to refer your loan to the Treasury and begin collecting on assets they know you have, like bank accounts and collateral. But they also have the ability to begin to garnish wages in order to collect on their debt.
Although you might feel tempted to ignore communications about your debt, the best thing you can do is engage in correspondence. You’ll incur additional penalties from both your lender and the government, potentially become embroiled in a lawsuit, and lose the opportunity to negotiate a payment plan that might work for you.
The bad new is that the SBA loan default process is lengthy and sometimes discouraging. When your business is in trouble, it never feels good. But there are several points along the way in which your creditors will work with you to avoid total default, and you should seize them when you have the opportunity.
If you’re concerned you might default on your SBA business loan, don’t wait to contact your lender. Reach out now to save yourself trouble—and money.