As a lender, you’ve probably seen this scenario before. You’ve referred a business acquisition deal or commercial real estate loan to an SBA partner, and it’s nearly at the finish line. The borrower is qualified with strong financials and a solid business plan, but the deal falls apart at the end because their equity injection funds trace back to a previous loan. What looked like a clear path to closing suddenly becomes much more complicated.
The SBA doesn’t allow borrowers to use any loan proceeds to fund their equity injection, and this mistake is one of the most preventable reasons that SBA deals stall or get flagged during review. But it doesn’t have to be this way. Clear communication about equity injection requirements and a strong relationship with an SBA lender can keep promising deals on track.
To help your clients avoid delays, it’s important to explain what an equity injection is, why the SBA requires it, and how recent rule changes may affect their loan. Let’s take a closer look at equity injections and how to make sure your clients understand the requirements.
What is an equity injection, and why does the SBA require it?
An equity injection is the borrower’s financial contribution to the deal. Essentially, it’s the down payment on the loan. Conventional lenders typically require 30%, but SBA 7(a) loans only require as little as 10%, often making a business acquisition or commercial real estate deal more realistic for the buyer. In the case of startups, equity injections can be 20% or higher as a way to derisk the deal as much as possible.
The SBA requires a minimum 10% equity injection, and it’s not just a formality. It signals that the business owner has real skin in the game, which reduces risk for the lender. Recent SBA rule changes have tightened the flexibility that previously existed around what qualifies, so communicating these requirements to your clients early can help avoid surprises as closing approaches.
What qualifies as an eligible equity injection
As a lender, part of your job is coaching borrowers through the lending process and explaining what qualifies as an eligible equity injection. Equity injections cannot be sourced from borrowed funds.
The following funds can be used and must be well-documented to be considered:
- Cash: Must be verified through bank statements with full sourcing documentation showing where the funds came from.
- Gift funds: Must be a true gift with no repayment expectation and accompanied by the proper documentation.
- Proceeds from asset sales: May include real estate, securities, and other business interests.
- Standby debt and seller notes: May qualify under specific conditions and must meet SBA standby requirements.
For each of these equity injection sources, lenders verify the full paper trail back to the origin of the funds and make sure the funds are “seasoned,” meaning they’ve been in the appropriate account for at least three months and don’t trace back to a loan.
Why loan proceeds cannot be equity
When borrowers use loans as their equity injection, it simply shifts debt from one bucket to another, defeating the purpose of the requirement—for borrowers to put some “skin in the game.”
When borrowers don’t understand these rules, they can unintentionally make an error that derails the process. This might include taking out a loan, receiving funds, and presenting it as cash equity, or relying on undisclosed debt. These mistakes can stall or completely derail an approval, often at the crucial moments before closing.
How to coach borrowers through it
While some borrowers may have extensive experience with SBA lending, others are navigating the process for the first time. We recommend starting the equity injection conversation before you make the SBA 7(a) loan referral and do your best to verify the source of the funds.
Tell your clients directly that equity can’t come from borrowed funds, and that they will be asked to show proof of seasoning, meaning the funds have been sitting in their account long enough to verify they’re not recently borrowed. This is typically documented with three months of bank statements. If you are able verify the client’s equity source and confirm the documentation is in place early, it sets them up for success when the process moves to underwriting and into close. Due diligence on equity injection sources is typically completed during closing, but these early moves help the process go smoothly and faster.
We’re here to help you navigate equity injections with confidence
Understanding equity injection requirements helps borrowers avoid surprises and keep deals moving toward closing. When questions come up, and they probably will, having a knowledgeable SBA lending partner can make all the difference.
At Grow America, we’re committed to helping referral partners navigate the SBA lending process with confidence. If you’d like to discuss a deal structure, verify an equity source, or learn more about our SBA 7(a) program, our team is here to help.
