:max_bytes(150000):strip_icc()/CananSBALoanBeForgivenJan.42021-c378b05e001e47f79dd49ffa90a08ff7.jpg)
Nora O'Malley covers small business finance and entrepreneurship topics for The Balance. Along with her writing work, Nora is an entrepreneur and consultant who opened an all-tap wine bar in New York's East Village dubbed Lois and owns a sophisticated snack food business Aida. For her businesses, Nora is responsible for finances, marketing, operations, and fundraising. Along with The Balance, her writing has appeared in Thrillist, Insidehook and Vinepair.
Updated on May 24, 2022 In This Article In This Article
New or nascent small businesses typically have limited options when it comes to financing their budding enterprises. Most traditional lenders require applicants to pledge significant collateral or show strong business financial statements to be approved for loans. Luckily, the U.S. Small Business Administration (SBA) offers a suite of loan products geared towards startups and burgeoning small businesses. These loans are issued by third parties—such as banks or credit unions—and guaranteed by the SBA up to 85%, so the risk is significantly mitigated for the lender.
However, if, during the course of business, an SBA loan recipient becomes unable to pay its loan, the lender will make attempts to collect any pledged collateral. The lender will then turn the debt over to the SBA. The government has standards and practices to recoup lost funds, but it may be able to settle with the loan holder for a reduced amount. This process can be costly and time consuming for the business owner but can ultimately result in a form of loan forgiveness.
We’ll discuss what happens when you default on a loan and how loan forgiveness works.
SBA loans are an ideal resource for small businesses that might not otherwise qualify for traditional loans. The SBA offers various loan products ranging from $500 to $5.5 million in funding, all with competitive rates, broad eligibility requirements, and reasonable terms. The federal government partners with third-party lenders, such as commercial banks or local credit unions. These lenders vet applicants, own the loan, and collect the interest.
The SBA sets the terms, conditions, and eligibility of each type of loan, and lenders must uphold those guidelines when evaluating applicants. Ultimately, these loans can be far less risky for the third-party lenders because the SBA guarantees a portion of the funds, usually somewhere between 50% and 85%.
There may come a time when a small business is unable to repay a loan issued by the SBA via a third-party lender. Perhaps you need to delay payment due to a cash flow issue, or maybe you’ve exhausted your resources and can no longer meet the payment terms. Regardless, once your business starts to miss its scheduled loan payments, you’ll become delinquent on your debt.
Each lender has different policies and procedures for collecting delinquent funds. Some may reach out to understand why you’re unable to pay and work with you to find a solution (i.e., partial payments, extending due date) to avoid default.
Some lenders will work with businesses for a few months to avoid sending a loan into default. But if a business continues to skip payments without an arrangement with the lender, then the latter usually has no choice but to send the loan into default. Defaulting on a loan is likely to have a very negative effect on your business’s credit, and often on your personal credit, as well.
Here is an outline of what happens if you default on an SBA loan:
Once a business has no more options for debt repayment, it may have to cease operations. At this point, any remaining collateral will be liquidated to pay back the SBA loan.
When it’s clear that there are no remaining assets to support loan repayment, the SBA will likely issue an “offer in compromise” to borrowers who cannot fully repay their loan. An offer in compromise arrives via a form from the government and the business owner must propose a settlement amount within 60 days.
A business must have ceased operations and liquidated all other collateral to be considered for an offer in compromise. The offer amount should have a reasonable relationship to the amount of the debt owed and be paid in one lump sum.
To have an offer in compromise approved, the business will also have to use financial statements to prove that the loan is in liquidation and that the business cannot support the loan payments. Generally, this is done through business and personal tax returns, financial statements, and any corroborating evidence regarding business and personal assets.
While the SBA will not forgive 100% of the debt owed, the goal is to settle on a number that makes sense for both the agency’s bottom line and a business’s financial ability to pay. If the SBA approves the offer in compromise, a payment will be issued and the loan will be classified as “Compromised/Closed.”
Small businesses commonly run into cash flow roadblocks that may make repaying a loan difficult. This is partially why the SBA loan program exists in the first place—to give otherwise relatively volatile loan candidates a fair shake at the necessary capital to grow and succeed. If a business simply can’t make its payments, however, the first thing its owner should do is be proactive with their lender.
Communication is key. Talking to your lender right away is always the best option when you are in danger of becoming delinquent. Some lenders may waive late penalties even after the designated grace period or restructure your payment plan to help you repay the loan.
Some banks and credit unions may be able to renegotiate loan terms, interest payments, or payment plans to ensure that you can avoid going into default.
Partial forgiveness for an SBA loan can be issued only after a loan is in liquidation and a business has ceased operations. At that point, the SBA will issue an offer in compromise as a way to settle the loan, usually for less than what is owed.
Under the SBA’s Interim Final Rule, the agency must issue a decision within 90 days after receiving a forgiveness application. If borrowers of Paycheck Protection Program (PPP) loans do not apply for forgiveness within 10 months after the last day of the covered period, then PPP loan payments are no longer deferred. Borrowers will then begin making loan payments to their PPP lender.
