How to Qualify for Modification or Deferment of an SBA Loan

Negotiating a modification or deferment on your SBA debt is an art—not a science. It is a delicate dance between the borrowing business, the guarantors and the lender. The company needs to prove it requires assistance, but it also needs to demonstrate that it is still a viable business capable of repayment. Show too much distress, and lenders will deny the request and likely elect to liquidate the business. In this case, the borrower may be forced to consider winding down her business or submitting an offer in compromise to avoid bankruptcy.

Conversely, if you demonstrate too much cash flow, the lender will also deny the request and demand regular payments, leaving the business and its owners with few options.

So how does an entrepreneur get a modification or deferment on her loan?

First, let us differentiate between these two terms.

SBA Loan Modifications

Businesses that qualify for an SBA loan modification are experiencing systemic issues that result in the debt service not being paid as agreed. These companies may be facing reduced revenues, increased competition, higher cost of goods or other long-term market forces that are adversely affecting financial performance.

Perhaps the original business plan never panned out, and the business environment for the foreseeable future is depressed. As a result, the owner finds himself in need of payment relief in order to remain in business. This type of relief is not the same as SBA loan forgiveness—where a debt workout renders a portion of the principal balance unpaid. In the case of a loan modification, the business owner intends to pay 100% of the amount owed, plus interest. He is merely seeking longer amortizations, balloon payments due at the maturity of the loan or a reduction in the interest—all with the goal of reducing the monthly debt service.

SBA Loan Deferments

Businesses that seek loan deferments are experiencing temporary cash flow issues such as seasonality, inventory crunches or past-due vendor payments. The relief they seek is short-term—long enough to address their cash flow concerns and get back to operating in the black. Loan deferments offer temporary relief to be followed immediately by regular payments once again. Deferments are typically between 30-90 days but can span for as long as the lender is willing and usually come in two primary forms.

Interest-only Deferment

The business continues to honor the interest portion of the note payment while the principal portion gets deferred.

Complete Payment Deferment

Both interest and principal get deferred in this scenario.

The type of loan and the business’ performance will determine which type of deferment is available to the borrower.

Step 1: Determine What Kind of Help You Need

Now that we understand the difference, let’s talk about what kind of business qualifies for an SBA loan modification or deferment. We’ll also identify what can you do to increase your chance of approval for this kind of relief.

First, you should clearly understand what type of relief you need. Because you are asking the bank to take less than what was agreed upon, you want to ensure that if you get what you’re seeking it will solve the problems you’re currently facing.

In other words, do you need a break from payments for 90 days to get through an unexpected sales slump? Or do you really need a longer-term loan modification because you can’t see the light at the end of the tunnel just yet? Similarly, don’t spend time pursuing a modification if you’re underwater and what you really need is an SBA loan settlement negotiation in the form of a debt workout.

Look at your business and the challenges it is facing. Are they something the company will recover from, or are you experiencing consistent performance that needs to be addressed? If you are unclear about what to do, call us for a free consultation.

Step 2: Prepare a Package for the Bank

Once you determine what type of relief you are seeking, it’s time to prepare a package so you and your bank can start negotiating.

Remember, the paradox here is that a business needs to prove that it cannot afford full principal and interest payments in order to obtain assistance. However, simply by seeking relief, you may be in technical default under your loan covenants and therefore faced with the possibility of liquidation. It is critical that you be confident in your ability to perform on the relief agreement requested. It’s also smart to seek the advice of an expert.

Deferment Package

Deferments are the simpler of the two types of relief. Nonetheless, they still require financial documentation: two years of tax returns, personal financial statements, balance sheets, Accounts Payable schedules, Accounts Receivable schedules and income statements, along with requests the individual lender may have.

The banker will then review these documents to determine if a deferment is warranted and whether or not they believe that regular payments will resume after the deferment expires. They make this determination by looking at the following items:

Business Performance

The bank will examine if the relief granted will resolve the short-term cash problems. They will evaluate your A/R position and determine the likelihood of there being enough revenue to cover operational expenses and honor the deferment agreement.

Business Collateral

The bank will review its collateral for the loan and evaluate its current value. They do this to determine how secure their lending position is. If the collateral has decreased in value and the business performance is poor, they may elect to liquidate now, rather than allowing for even more depreciation.

Guarantor Character

The bank will also account for their working relationship with you. They will examine your performance and determine whether you pay reliably, evaluate your communication and candor, and decide whether or not you are likely to honor your commitment.

Modification Package

SBA loan modifications can be a more complicated request, simply because the relief sought is long-term. In our experience, bankers review loan modification requests in a similar manner to deferment requests, with one major downside.

The documentation supporting the request is similar: tax returns, personal financial statements and business financials. In addition to using the three criteria listed above, the bank also makes projections for the business’ future performance—without input from the owner. Banks figure they must have some expectation of future business performance in order to guess at the likelihood of a business honoring a loan modification. Unfortunately, allowing the banks to complete this exercise without the business owner’s input often results in inaccuracies that have negative consequences.

For this reason, we suggest that every modification request includes the following two pieces, even if the lender does not request them:

Letter of Explanation

The letter requesting your loan modification should be formal. It should summarize all conversations you’ve had with your banker, discuss the current financial standing of the company, and spell out exactly what is being requested and why your business will be able to honor such a request.

Cash Flow Pro Forma

Many business owners have no experience when it comes to making projections. A pro forma demonstrating the business’ cash flow is a critical component for obtaining a modification, so seek help if you do not know how to put one together. The goal is to provide precise, month-by-month projections for at least the next year, taking the guesswork out of the equation for the bank. This prevents them from drawing inaccurate conclusions about your business’ future.

Often the final decision is made by committee—not just the representative with whom you’re used to speaking. While that person might have a relationship with you, it’s likely the others do not, so these two components of your package will ensure your voice heard. This is your best chance of affecting the final outcome.

If at any point during this process, you have questions or need help, Second Wind Consultants is here to assist. Schedule your free consultation, and we’ll create a plan to fight for your best interests and see to it you receive the best relief possible.