SBA loans and turnarounds are two phrases you may not be use to hearing together. In our experience, it isn’t well-known that flexibility does in fact exist for an SBA lender to accomplish a turnaround. However, they can go hand-in-hand with some knowledge about the process. Planning for and accommodating lender and SBA requirements is necessary when a loan is in distress as the lack of documentation can null and void all good turnaround efforts. Losing the turnaround upside can cause a lender to further suffer “repairs” to the SBA guarantee creating unnecessary lender losses.
Planning for an SBA Loan Turnaround
In order to successfully achieve a turnaround (and highest loan recovery) where an SBA loan exists, we advise the following process. While this is not a complete set of instructions, it is fairly comprehensive. There are several things that must happen up front in a good plan. Among them is some documentation of what the borrower will do, and what the borrow has done to help the lender – what’s known as consideration.
1. Perform Due Diligence
Documentation is key. Collect the guarantor’s personal financial statement (SBA Form 770) and ensure it’s signed and less than 90 days old. You’ll also need 2 years of the business’ tax returns and 2 years of personal tax returns on 20% or more owners. Review loan documents and clear any exceptions you can.
Physically, it’s important to conduct a site visit. Observe the condition of collateral and working assets like equipment and inventory in order to determine the ability to produce revenue under the workout agreement. Use all the information you’ve collected to assess the business’s ability to succeed under a workout agreement.
Put your plan in writing. Include a list of events of default to date. Confirm collateral including who has priority position on various assets. Define a forbearance period, the workout options employed, and the events that constitute a default under the workout as well as the consequences of default under the workout agreement. The lender and the borrower must sign this plan. Also, at this point, it may be necessary to get a fresh set of eyes on the situation to assess what is really achievable. Understand that while the SBA is watching, they encourage lenders to take proactive unilateral steps to fix the situation and help the owner turn the company around.
The workout plan must move from concept to implementation within 60 days of the default. If this cannot happen, enforced collection must be pursued. There are several things that must happen up front in a good plan. Among them is some documentation of what the borrower will do, and what the borrow has done to help the lender – consideration.
Consideration is required for a workout plan. Examples of consideration include:
- Correct Loan Document errors
- Waive defenses
- Release lender liability claims
- Provide additional collateral
- Consent to a speedy and inexpensive method of liquidating the loan if the workout fails
Be sure to provide a written workout plan following all steps found in SOP 5057-2 (Just revised released). SBA does not have to approve the plan; it’s typically a unilateral action unless the principal balance is being compromised as part of the plan.
While there is no requirement for a 13-Week Cash Flow Model, we believe a prudent lender would employ one. It is the fastest way to determine if a plan is working. At the least, financials should be collected at least quarterly, if not monthly.
6. Deferment and Modification
Consider the three elements that show the SBA can be flexible:
- Forbearance: enforced collection activities may be postponed for a stated period of time in order to provide the borrower with an opportunity to improve its cash flow and avoid foreclosure
- Deferment: delinquent and future payments of principal, interest, or both may be deferred for a stated period of time to enable the borrower to overcome a temporary cash flow problem
- Modification of repayment terms of Note: the repayment terms of the Note may be modified, including lowering the payment amount or interest rate or extending the maturity date of the loan.
The priority position of a lien securing the loan may be subordinated to a short-term working capital loan. This is unique to the SBA and not possible in most conventional loans showing more flexibility by the SBA. It is not typical for lenders to do this, but it possible with the SBA’s support.
8. Sale of assets
The borrower may be allowed to voluntarily sell all or part of the collateral, However, the sale must be closely monitored in order to ensure it is commercially reasonable and that all of the net proceeds are applied to the principal balance of the SBA loan or used to facilitate the workout plan. “Commercially reasonable” is defined as obtaining appraisals and valuations. In order to make a sale of a distressed business work, these actions must be completed before a sale happens. It requires coordination and working with a professional who can manage this extra effort in a timely fashion.
If you are involved in a relationship with an SBA loan and a distressed company, Newpoint can help. Our Cash Flow Launcher will create a 13-Week Cash Flow Model that quickly identifies areas of concern and uses actual transaction data to better analyze and scrutinize forecast assumptions. Contact us today for a consultation.