Haris Ashley
If you're applying for an SBA loan, you may be surprised to learn that you'll need to take out a life insurance policy before your loan application can be approved. This is because the Small Business Administration (SBA) doesn't lend money directly, but instead connects entrepreneurs with approved business lenders. The SBA then agrees to back a portion of the loan on behalf of the business owner. This means that, in the event of the business owner's death, the life insurance policy will cover the cost of the loan.
| Characteristics | Values |
|---|---|
| Purpose | Protects the lender and the owner's family |
| Requirement | Depends on the type of SBA loan and the business structure |
| Policy Type | Term life insurance is the most common and cost-effective option |
| Policy Value | Should meet or exceed the outstanding amount due on the SBA loan |
| Active Policy Status | Should be in effect before the loan is issued |
| Collateral Assignment | Properly documented and signed before the loan is issued |
| Length of Coverage | Should cover the loan's repayment time frame |
| Turnaround Time | 4 to 6 weeks on average, but can be faster with advanced technologies |
| Cost | Depends on age, health, and the amount and duration of the policy |
| Existing Policy | May not be sufficient due to collateral assignment rules and coverage needs |
| Affordability | The SBA may build the cost into the loan payment or offer pay-in-full discounts |
| Multiple Owners | Each owner may need their own policy or a "key person" policy may be required |
What You'll Learn
- The Small Business Administration (SBA) doesn't loan money, but it does facilitate loans by connecting entrepreneurs with approved business lenders
- The SBA requires life insurance to protect its investment in your business
- The lender will assess the business, including how viable it would be without its main principle
- The type of business structure will determine if a lender requires life insurance
- The SBA 504 loan and SBA 7(a) loan have different requirements for life insurance
The Small Business Administration (SBA) doesn't loan money, but it does facilitate loans by connecting entrepreneurs with approved business lenders
The Small Business Administration (SBA) is a federal agency dedicated to helping small businesses in the U.S. It does so by providing counseling, access to government contracts, and loans, among other things.
The SBA doesn't lend money directly to small businesses. Instead, it facilitates loans by connecting entrepreneurs with approved business lenders and guaranteeing a portion of the loan amount. This guarantee encourages lenders to finance small businesses that they might otherwise reject.
The SBA has a primary program for providing long-term financing for a variety of purposes. 7(a) loans are delivered by SBA 7(a) lenders and can be used for most business purposes, including long-term fixed assets and operating capital. The SBA also offers lines of credit, real estate loans, and business acquisition loans.
To get an SBA-backed loan, you need to enter basic information about what you're looking for on Lender Match, create an account to start talking to interested lenders, and then the lenders will approve and help you manage your loan.
The SBA only makes direct loans in the case of businesses and homeowners recovering from a declared disaster.
Now, when it comes to getting life insurance for an SBA loan, this is a requirement that often surprises small business owners. It's needed because it protects everyone involved if the business owner or a partner passes away. It's important to note that every small business loan is different, so there's no blanket answer for when life insurance will be required. However, an SBA 7(a) loan typically requires life insurance for the full loan amount, while for an SBA 504 loan, life insurance is usually only required if your collateral doesn't fully cover the loan.
If you already have a life insurance policy, you can assign part of it as collateral coverage. Alternatively, you can take out a new policy that includes your lender as an assignee. It's recommended to start the process of setting up a new life insurance policy early in the loan application process, as it can take some time.
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The SBA requires life insurance to protect its investment in your business
The Small Business Administration (SBA) Loan Program is designed to help new and existing small businesses secure the funding they need to grow or expand. The SBA acts as a guarantor for a portion of the loan made by participating lenders, usually banks. In doing so, the SBA assumes a level of risk, which is mitigated by requiring life insurance on the loan. This is particularly important as many small businesses are dependent on the expertise and skills of a single key person for their success and survival.
The SBA's life insurance requirement ensures that, in the unfortunate event of the borrower's death, the loan can still be repaid in full. This protects the lender's interest and also shields the borrower's family from inheriting the outstanding business loan. Instead, the life insurance policy will pay off the loan.
The SBA's life insurance requirement is outlined in the SOP 50 10 5(H), Lender and Development Company Loan Programs manual provided by the U.S. Small Business Administration's Office of Financial Assistance. Specifically, the SBA requires life insurance for loans processed under the standard 7(a) program that are over $350,000 and are not fully secured.
The life insurance policy must be for the full amount of the SBA loan, and the lender must be named as the primary beneficiary. This ensures that, in the event of the borrower's death, the lender will receive the funds necessary to cover the outstanding loan balance.
It is important to note that the SBA does not specify the type of life insurance required to secure a loan. Term life insurance is the most common type of policy purchased for SBA loans, as it is cost-effective and provides coverage for a set number of years, typically sufficient for the loan to be repaid.
The life insurance requirement is an important aspect of the SBA lending process, and it is recommended that borrowers start exploring their life insurance options early in the loan application process to avoid delays.
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The lender will assess the business, including how viable it would be without its main principle
When it comes to assessing the viability of a business, lenders will typically consider a range of factors, including financial statements, projections, and non-financial factors. Here are some key aspects they might evaluate:
Earnings and Cash Flow
Lenders will often look at the business's earnings, specifically the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). They will assess if the EBITDA consistently exceeds the demands on earnings over several trading years, indicating positive cash flow and viability. However, it's important to note that EBITDA has its limitations and shouldn't be the sole measure. Lenders might also consider other factors, such as net movements in working capital, tax paid, and capital expenditures.
Net Worth and Balance Sheet Strength
A business with a strong balance sheet, where assets exceed liabilities, can be considered more viable. If the net worth is increasing, it is a positive sign of financial health. Even if the business faces challenges, a strong balance sheet can provide a buffer and give owners time to implement turnaround strategies.
Financial Projections
Lenders will also assess the business's financial projections, including integrated profit and loss statements, balance sheets, and operating cash flow forecasts. These projections should be based on reasonable assumptions and help understand the impact of internal decisions and external risk factors.
Financial Trends and Non-Financial Factors
The trend of earnings, cash flow, and net worth over multiple years will influence a lender's assessment. Additionally, they will consider non-financial factors such as the economic outlook, the sector the business operates in, management experience, and any applicable risks.
Financial Support Team
The lender will also consider the expertise and support available to the business. This includes the presence of a finance director, manager, or external advisers who can provide financial insights and guidance.
Business Model and Customer Base
Lenders will assess the uniqueness of the business model and its ability to stand out from the competition. They will also evaluate the business's customer base and whether it aligns with the target demographic.
Timing and Seasonality
The timing of the business launch and its potential seasonality will be considered. Lenders will assess if the business is opening during an appropriate time frame to capture the strongest consumer demand.
Marketing Strategy
The effectiveness of the marketing strategy in reaching the target customers will also be evaluated. Lenders will consider the business's ability to utilize online tools, coupons, mailing lists, and other creative approaches to attract customers.
Risk Assessment
Lenders will conduct a risk assessment to determine the likelihood and potential consequences of a financial viability issue during the loan period. They will consider factors such as the nature of the business, the industry's maturity, economic conditions, and historical financial failures within the industry.
Overall, the lender's assessment of the business's viability will involve a comprehensive evaluation of financial metrics, business operations, and external factors. This assessment helps determine the creditworthiness of the business and the likelihood of loan repayment.
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The type of business structure will determine if a lender requires life insurance
The SBA's role is not to lend money but to guarantee a portion of the loan made by participating lenders, usually banks. The lender initiates the loan, and if the SBA agrees to provide guarantees, the lender funds and services the loan. The SBA offers several types of loan options, but the most common is the 7(a) Loan Program.
Under the 7(a) Loan Program, if the loan is not fully secured, life insurance is required for sole proprietorships, single-member LLCs, or businesses otherwise dependent on one owner's active participation. The amount and type of collateral available to repay the loan are factored into determining the appropriate amount of life insurance.
The SBA requires a life insurance policy to secure a small business loan when the small business is closely connected to one or more business owners. This means that if the viability of the business is tied to an individual or individuals, the lender must require life insurance. This is to protect the lender and the owner's family in the event of the owner's death.
Therefore, the type of business structure will determine whether a lender requires life insurance. If the business is a sole proprietorship or a single-member LLC, or if the business is dependent on one key person, life insurance will likely be required for a small business loan.
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The SBA 504 loan and SBA 7(a) loan have different requirements for life insurance
The SBA 504 loan and SBA 7(a) loan have distinct requirements for life insurance. While both are small-business loans guaranteed by the US government, they differ in the purposes for which they can be used.
The SBA 504 loan is used to finance real estate purchases or renovations, or to buy equipment. Life insurance is not typically required for the SBA504 loan. However, if the collateral coverage is deemed insufficient or you are the sole operator of the business, you may be asked to assign a portion of your life insurance policy to bridge the gap.
On the other hand, the SBA 7(a) loan is the SBA's most popular loan program and can be used for a wider range of purposes, including working capital, purchasing furniture and fixtures, leasehold improvements, acquiring an existing business, or buying land and existing buildings. An SBA 7(a) loan typically requires life insurance for the full loan amount. However, this requirement may be reduced or waived if you have pledged significant collateral or have a succession plan in place.
In summary, the SBA 504 loan is more likely to require life insurance if your business relies heavily on one key person, whereas the SBA 7(a) loan generally requires life insurance but may waive or reduce this requirement under certain conditions.
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Frequently asked questions
The average turnaround time for life insurance applications is 4 to 6 weeks. However, if you are in a hurry, non-medical exam term life insurance policies can be approved in as little as 1 hour. No-exam policies can be approved within 2-3 days, while policies that require a medical exam typically take 2-4 weeks.
Term life insurance is the most common type of life insurance purchased for an SBA loan. It is the most cost-effective option and can be tailored to match the exact maturity of the loan. No-exam term life insurance is a good option if you need coverage quickly, although it is usually more expensive.
The first step is to determine whether you need life insurance for your SBA loan. This will depend on the structure of your business and the lender's requirements. If you do need life insurance, you will need to find an insurance agent, ensure the term of the policy is longer than the loan's repayment schedule, apply, release records, and schedule a medical exam if required.
