The end of the first quarter marked the start of a fundamental shift in the U.S. economy. While private lenders rushed to freeze new loans until they could get a sense of what was coming in terms of earnings, unemployment, and the spread of the coronavirus, the federal government moved quickly to expand public credit facilities for distressed banks and small and medium-sized businesses.
Enter, the U.S. Small Business Administration (SBA) 7(a) and 7(b) programs. In late March of this year, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which, among other things, approved nearly $350 billion in funding for the SBA to provide to small businesses.
The SBA was directed to provide new 7(a) loans to small businesses through the Paycheck Protection Program (PPP), as well as Economic Impact Disaster Loans (EIDL), issued directly by the SBA through its 7(b) program.
SBA 7(a) vs. 7(b) funding
While both SBA 7(a) and 7(b) loans are designed to provide emergency funding for small businesses in response to the coronavirus pandemic, these loan programs have several key differences.
The SBA's 7(a) (or PPP) loan was designed to provide emergency loans to businesses that employ up to 500 people. These loans are limited to 2.5 times a company's fixed monthly expenses, including payroll, up to $10 million. Loans are issued by SBA-approved lenders and guaranteed by the SBA.
The SBA's 7(b) (EIDL) program is a new type of SBA disaster loan that is issued directly by the SBA and provides up to $2 million per applicant. While historically SBA loans have been limited to small business owners who have employees, the CARES Act also directed the SBA to make these loans available to self-employed individuals, part-time employees, independent contractors and gig workers.
SBA emergency loan response
In the first several weeks after the SBA's new loan programs were made available, more than 3 million applications have reportedly been submitted for the Paycheck Protection Program alone, with many of the nation's leading banks receiving tens of thousands in the first hours of accepting applications.
Out of 3 million applications, the SBA has reportedly approved about 1.6 million PPP loans – an approval rate of less than 55%. The percentage of businesses that have received the full funding they requested is even lower. Still, the first round of funding approved by Congress ran out in just 14 days.
With millions of businesses clamoring for funds to survive this crisis, it's extremely important for small business owners to watch out for these 10 things when considering either SBA 7(a) or 7(b) funding.
1. Qualification requirements
The SBA's Paycheck Protection Program loans, which are issued through the traditional 7(a) program, are designed to provide funding for businesses that have W-2 employees. While the SBA's stated limit to qualify is 500 employees, there are some exceptions being made in certain industries. However, the PPP is designed primarily to support companies that need funding to retain employees and pay fixed expenses like rent or utilities.
The EIDL program, on the other hand, is relatively broader and can provide funding to gig workers, self-employed individuals, and independent contractors, in addition to traditional small business employers.
Applicants for EIDL loans must document their income using tax returns,1099s, bank records and other documents that reflect their drop in revenue. If you left your job earlier this year to freelance full time, you may have trouble qualifying for an EIDL.
2. Restrictions on the use of funds
Funds that are borrowed through the SBA's PPP or EIDL program can be used for anything. However, these loan programs are designed to help businesses make payroll and pay fixed expenses. Or, when provided directly to independent contractors and self-employed individuals, they're to replace lost revenue or wages, and cover expenses for things like rent and fixed debts.
While funds provided through these programs can technically be used for anything, failing to use funds to pay things like payroll or covering fixed expenses can preclude borrowers from having their PPP loans forgiven in the future. Instead, the PPP loans will have to be paid back in full over time.
3. Affiliate rules
The SBA has rules about providing loans to affiliated companies that have the same owners or managers, and these rules apply to 7(a) and 7(b) loans.
There are also rules that apply to affiliate companies, which are those that share common majority ownership (50% or more) or share senior management (e.g., the same CEO, CFO and vice presidents). In cases where any single affiliated company exceeds SBA size limits or all affiliated companies in aggregate exceed size limits, companies may not qualify for either SBA 7(a) or 7(b) loans. It is best to review the SBA website for questions regarding affiliates.
4. 7(a) loan forgiveness conditions
Business owners who use SBA 7(a) PPP funds to pay employees and cover fixed expenses like rent, utilities or long-term debt payments for eight weeks after they receive their loans can apply to have their loans forgiven. However, if funds have been used for other purposes, the entirety of the loans likely won't be forgiven.
Although the SBA has established clear guidelines around the forgiveness of loans used to pay employees and cover fixed costs, there's still ambiguity about whether loans will be partially forgiven if they're used in part to pay fixed expenses or meet payroll. Business owners will need to stay up to date on this as the SBA releases additional guidance and as the government's response to the coronavirus pandemic changes.
5. Being charged unnecessary fees
To make it easier for small businesses to access this much-needed financing, the SBA is waiving many conventional loan charges, including guaranty fees, which lenders shouldn't be charging. Borrowers shouldn't be charged these fees for Economic Impact Disaster Loans, either, as those are being issued directly by the SBA.
Granted, if you use a broker to help you prepare your application or compile documentation for either loan program, they may have their own fees.
If small business owners think that SBA 7(a) or 7(b) loan funding may be right for them, they need to move quickly and decisively. The funds available for these loan programs are capped, and the first round approved by Congress ran out in just 14 days.
Both Congress and the White House have signaled that they intend to replenish the funds available through these programs, but no one knows how large subsequent funding rounds will be. Many lenders have already suggested they expect future rounds to run out even faster than the first.
If you're considering using 7(a) or 7(b) funding, it's important to assemble your application with any necessary supporting documents. These can be tax returns, payroll statements, previous 1099s, bank records, etc. If you've decided to apply, be ready to submit your application as soon as the next round of funding becomes available.
7. Loan terms
PPP loans issued by the SBA can last a maximum of two years and charge 1% annual interest if they're not forgiven. EIDL loans, on the other hand, can last up to 30 years but charge 3.75% interest for for-profit companies and 2.75% for nonprofits.
These are the maximum terms for SBA 7(a) and 7(b) loans, but companies have the option of paying back loans early if they want without any prepayment penalties.
8. Maximum advance rates
The maximum amounts that business owners can borrower through the SBA's PPP and EIDL programs have been one of the most significant sources of uncertainty, in part because guidance appears to be changing.
The SBA's 7(a) (PPP) loans allow businesses to borrow up to 2.5 months of payroll and fixed costs up to a maximum of $10 million. This limit has been relatively consistent since initial guidance was released by the SBA.
The EIDL program, on the other hand, has a stated maximum of $2 million per loan. However, the SBA also explained that the maximum advance for borrowers is $2,000 per employee up to $10,000. Then, the limit changed to $1,000 per employee up to $10,000. The advance does not have to be repaid, even if the business is not approved for an EIDL loan.
Whether you're considering 7(a) or 7(b) funding, review the prospective loan amounts with the loan officer before signing a loan agreement, if not before applying.
9. Your provider's preferred lender status
If you've decided to apply for an EIDL, you can apply directly through the SBA. However, if you're going to apply for the PPP, you'll need to apply through an SBA-approved 7(a) lender.
While there are many lenders who can help business owners qualify for SBA loans, some lenders may make it easier to get a loan. In some cases, using the right lender may determine whether a business is able to secure an SBA loan at all.
Many smaller community banks are designated as preferred lenders by the SBA. This can increase an applicant's chances of getting approved for a loan or help them get approved faster. You may want to check your lender's status before applying, especially if you don't already have an established relationship.
10. Tax treatment of forgiven loans
Both the PPP and EIDL programs offer business owners federally guaranteed loans, part of which may be forgiven, if funds are used for certain purposes. But how forgiven loans or parts of loans will be treated for tax purposes remains unclear. Under normal circumstances, forgiven loans are considered income and taxed as such. Indications have been given that forgiven loans won't be taxed, but it remains to be seen what questions this may raise at tax time next year.
The SBA 7(a) Paycheck Protection Program and the SBA 7(b) Economic Impact Disaster Loan program were authorized and funded quickly in response to the severe economic downturn caused by the coronavirus pandemic.
While these programs are available now and are receiving more applications every day, no one knows how long the programs will last. Both programs have previously run out of money, and while we have every indication that the programs will be renewed, no one is sure how well they'll be funded or how many times over.
Still, for many business owners, 7(a) and 7(b) loan funding are their best options for financially surviving the crisis. Business owners first need to determine whether they're eligible for either the PPP or EIDL and how much they may be able to borrow. Business owners then need to decide which product – or what combination of the two – is right for them and move quickly to secure funding before the money runs out.