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SBA 7(a) Paperwork Explained: Lender's Credit Memorandum
For SBA Loans of $350,000 or less, the lender will perform a thorough and accurate credit analysis of your finances to show proof that you have the ability to repay your loan. The compilation of this information and documentation is called a Lender's Credit Memorandum.
The SBA definitely places importance on your credit score. However, lenders still like as little risk as possible when they're looking to approve a business owner for a small business loan.
That's why many lenders prefer to use the 7(a) Lender’s Credit Memorandum. Here's how it works: the Lender's Credit Memo contains information about your creditworthiness. The lender passes this document along to the SBA.
Take your preparation of this memo seriously, since the SBA seems to be cracking down on poor documentation and what they call “sloppy underwriting.”
What Goes Into the Lender's Credit Memorandum?
While the goal of the memo is for you to persuade the lender that you're trustworthy, ,the document should be specific and objective – not emotional or simplistic. The Lender’s Credit Memorandum should also exactly match the information you provided on the SBA Form 1919.
The information you present in the Credit Memorandum will determine whether or not you seem capable of repaying the loan. Lenders often use their own scoring criteria to judge your credit history, your character and reputation, and the strength of your business.
The SBA will be interested in why you can’t obtain credit elsewhere, and if you can support loan repayment with your own cash flow. Your lender’s explanation needs to be specific enough to show an identifiable weakness in your credit and still reassure the SBA that you’ll be able to pay.
While the purpose of the SBA 7(a) Lender’s Credit Memorandum is to persuade the SBA to approve the loan, you and your lender should do your best to communicate honestly. However, there are a few tips you can use to present your case in the best possible light:
One analysis showed that the average approved memo uses just slightly more positive words than negative. Try using positive words, even when explaining negative events.
The credit memo should focus on identifying the three to five largest risks related to the loan, and then present any mitigating factors that would reduce those risks. Mitigating factors could be found in your business structure or related to cash flow or collateral.
Don't include risks that affect every borrower, such as a widespread recession.
Share the weaknesses of your financial situation first, then the strengths. Finally, make a good case for why the strengths outweigh the weaknesses.
What is the history of your business?
Who makes up your management team, and what are their industry and management credentials?
Compared to total Debt Service Coverage, is your net operating income ratio at least 1:1?
Has your lender reconciled your business and personal financial data against IRS transcripts?
Can you provide an owner/guarantor analysis?
Can your lender confirm life insurance requirements?
Can you justify and specifically explain any refinancing?
Assuming your lender is recommending approval, have they documented how they made their decision?
Can you provide a credit analysis?
Is a change of business ownership involved? If so, can you show a business valuation explains how this change of ownership benefits your business?
Can you explain any relevant liens, judgments, and bankruptcies?
Do you have details on your collateral?
Have your historical financial statements been reviewed and analyzed by your lender?
Has your lender explained how they estimated your projected cash flow?
Do you have any working capital?
Full contact information.
Loan request. Include pricing and terms and conditions.
Comprehensive credit analysis. Include cash flow, collateral, key ratios, trend analysis, and management analysis. The SBA may value management analysis over financial analysis, so the memorandum drafter must explain why your management is a key factor in reducing risk.
Formal, detailed risk assessment and risk mitigation.
Appendix and supporting materials. If you need to include financial spreads for cash flow, collateral coverage or stress testing, add and label it in this section.
Did your lender address life insurance?
Did your lender verify and certify all financials against official IRS transcripts?
Is a schedule of collateral both included and complete?
Do your draft authorization and credit memorandum sync?
Is your "use of proceeds" explanation completely clear?
Have your notes to be refinanced been clearly identified?
Is any justification for refinance properly addressed?
Has your need for working capital been fully addressed?
Has any derogatory credit been clarified?
Has any collateral shortfall been clearly addressed?
Are all projections clearly justified?
What is an SBA 7(a) loan?
The SBA 7(a) loan is a federal government guarantee of a small business loan. Although the loan itself comes from a private lender, owners who qualify for SBA 7(a) loans have a significant portion backed by the government, making it much easier for businesses with less access to capital or problems with credit to receive financing.
Loans of up to $5 million qualify under SBA 7(a), with the SBA providing a guarantee of up to $3.75 million, or 75%. For loans worth less than $150,000, the government will back up to 85% of the debt. To qualify under this program, borrowers must meet SBA standards of being a small business, not have defaulted on previous government loans, and demonstrate the ability to repay the loan.
While there is a prepayment penalty on loans that mature beyond 15 years, there's no prepayment penalty for shorter-term loans. SBA 7(a) doesn't have a balloon payment, and provides improved cash flow for the business. SBA 7(a)-backed loans can be used for various business purposes, including renovations, capital purchase, seasonal lines of credit, or refinancing of existing debt.
The SBA in SBA 7(a) stands for the Small Business Administration, a federal department that helps encourage and subsidize new small businesses. The SBA 7a loan is one of the most popular commercial loans offered by the SBA, and is geared toward new borrowers and those borrowers who may be considered “weak” in their financial position.
If you qualify for an SBA 7(a) loan, the SBA will partially fund your loan through a private lender. The thought is that this incentivizes lenders to fund borrowers who they might not want to take the risk on otherwise.
What is a Lender's Credit Memorandum?
A Lender's Credit Memorandum is a document used to persuade the lender that a borrower is trustworthy and capable of repaying the loan. It should be specific and objective, and should match the information provided on the SBA Form 1919. The document should focus on identifying the three to five largest risks related to the loan, and then present any mitigating factors that would reduce those risks. It should also include information such as the history of the business, the management team's credentials, debt service coverage, net operating income ratio, owner/guarantor analysis, life insurance requirements, refinancing, credit analysis, change of business ownership, liens, judgments, bankruptcies, collateral, historical financial statements, projected cash flow, and working capital.
What documents are required for an SBA 7(a) loan?
The documents required for an SBA 7(a) loan include:
- SBA Form 1919 (borrower information form)
- SBA Form 912 (statement of personal history)
- SBA Form 413 (personal financial statement)
- Financial statements, including a balance sheet, profit and loss, and income projection
- Agreement to purchase the business
- Letter of intent to buy the business
- Business tax returns for the past three years
- Any outstanding business debt
- Long-term business contracts
- Documentation of business assets
- Business lease agreement
- Incorporation documents and/or business license
- Business plan
In addition, the SBA will usually order an independent business appraisal to give lenders an idea of what the true value of the business is.
The SBA allows applicants to get help (for example, from a lawyer or a translator) filling out the application paperwork, but your lender will be required to submit information about who gave you help to the SBA, so you’ll need to document who this person is as well.
What information is included in a Lender's Credit Memorandum?
A Lender's Credit Memorandum includes full contact information, a loan request with pricing and terms and conditions, a comprehensive credit analysis with cash flow, collateral, key ratios, trend analysis, and management analysis, a formal, detailed risk assessment and risk mitigation, and an appendix and supporting materials with financial spreads for cash flow, collateral coverage or stress testing.
How does a Lender's Credit Memorandum affect the SBA 7(a) loan process?
The Lender's Credit Memorandum is an important document in the SBA 7(a) loan process. It is used to persuade the SBA to approve the loan and should be specific and objective. The information presented in the Credit Memorandum will determine whether or not the borrower is capable of repaying the loan. The SBA will be interested in why the borrower can’t obtain credit elsewhere, and if they can support loan repayment with their own cash flow.
To increase the chances of Credit Memo approval, the document should be as clear and transparent as possible. It should include a brief description of the history of the business and a more detailed description of the management team, verified IRS transcripts, and a breakdown of how the loan proceeds will be used. It should also explain how the business generates its income, document collateral in-depth, and address any credit elsewhere. Additionally, it should include specifics on equity and seller financing, including applicable terms and uses, and a lease schedule summary (if applicable).
When writing the Credit Memorandum, it is important to get to the point quickly and use organizational elements such as headings, bullet points, and boxes to call the reader’s attention to the right information. It is also important to use positive words, even when explaining negative events, and to focus on the three to five largest risks related to the loan and present any mitigating factors that would reduce those risks.
Increasing the Chances of Credit Memo Approval
For your Lender’s Credit Memorandum to have the best chance of avoiding SBA screen-out, be as clear and transparent as possible. Set the stage by providing a brief description of the history of your business and a more detailed description of your management team. Include relevant details about their management and industry experience. The SBA also requires verified IRS transcripts, and expects you to break down how you plan to use all loan proceeds.
The SBA also expects your 7(a) Lender's Credit Memorandum to explain how your business generates its income. For this, include clarification for any past or current issues. Be sure to document your collateral in-depth, with attention to SBA collateral requirements (including life insurance).
Provide specifics on equity and seller financing, including applicable terms and uses. The SBA will also be looking for you to address any credit elsewhere (such as life insurance, affiliation, franchise info and working capital), as well as existing shareholder debt. Attach backup documentation wherever you can.
Get to the point quickly. Due to the number of applications for SBA 7(a) loans received by the SBA, the clarity of your Lender’s Credit Memorandum will increase the likelihood of positive reception. Only a few minutes are generally spent evaluating each loan, so try using organizational elements such as headings, bullet points, and boxes to call the memo reader’s attention to the right information – and quickly.
Don’t forget to include a lease schedule summary (if applicable)! The SBA’s assessment of your cash flow and stability is very much impacted by your lease structure and credit, which many Lender’s Credit Memorandums tend to omit. You’ll need to explain the terms, price, renewal options, lease credit strength, and any co-tenancy clauses.
Get Ready for Your Lender’s Credit Memorandum
You should be able to answer the following questions, which your SBA 7(a) Lender’s Credit Memorandum needs to address:
SBA 7(a) Credit Memorandum Format
Once you’ve prepared by answering the questions above, the information needs to come together in a simple and consistent format. The document can be structured however you like, but be sure it includes all of the following clearly and concisely. Break it down into sections for readability, and include:
Double Check Your Credit Memo – Then Check Again
Once your memo is complete, be sure to fully review your Lender’s Credit Memorandum for the most common reasons an SBA 7(a) gets denied during credit memo review:
And of course, if you have any questions at all about the SBA 7a Loan application process, don't hesitate to message us. We're here to help!
Or, simply click the button below to apply for an SBA loan quote today!