Many people rely on loans to start or grow their small businesses. Financing is often a critical part of turning a dream into reality. Small businesses use loans for everything from working capital to purchasing equipment to marketing initiatives.
When businesses fall into hardship, it can become difficult to make payments on loans. While banks will often try to create work-out plans with struggling borrowers, this becomes trickier if the loan is guaranteed by the Small Business Administration.
One way to get some relief is to submit a request for an SBA offer in compromise (OIC). Getting approval for your OIC can mean the difference between being crushed by your SBA debt and being able to pay back a much smaller amount.
Defaulting on an SBA Loan
If you begin to fall behind on your loan payments, your lender will attempt to collect. This can include everything from repossessing the assets used as collateral on the loan to making a demand on the guarantors.
Any guarantors will have signed a guarantee document. The guarantee is a legal promise that you will personally pay back the loan if your business cannot. The SBA requires personal guarantees from any borrowers owning 20% or more of the business or those that have key management positions.
The SBA also holds a guarantee on the loan, but in a different way. The SBA’s guarantee says that in the event of default if the bank fails in its collection efforts, the SBA will repay the bank. This can be up to 85% of the loan amount.
As the lender begins its efforts to collect from the business, it will turn to the guarantors and make demands as well. If all efforts to collect fail, the bank will request that the SBA honor their guarantee. If the federal government takes a loss, it may take additional steps, such as freezing the borrower’s bank account or garnishing wages.
If you default on an SBA loan, an offer in compromise is an agreement that you could reach with the SBA. You would pay a smaller portion of the full amount due. In exchange, the SBA considers the debt to be completely paid off.
Who Is Eligible for an Offer in Compromise?
On an SBA Form 1150, you would make an offer and state your case for the SBA to accept your offer. You must meet certain requirements to submit an SBA loan offer in compromise, which the SBA has outlined:
- The amount offered is reasonable compared to the net amount that can be recovered through collection efforts.
- There was no fraud or misrepresentation.
- Borrowers and guarantors fully disclose their financial capacity.
- Borrowers have ceased all operations, and all business collateral (assets) has been liquidated.
- The participating lender agrees with the offer being presented.
- A value for any real estate mortgaged to the SBA is valued and supported.
- Sources of funds for payment of the offer are clearly identified.
Making the Offer to the SBA
Based on the eligibility criteria, you must wait to begin the process for an offer in compromise (OIC) until the business is closed and the assets liquidated. Your OIC proposal is usually submitted to the SBA through your lender, so you will want to confirm that your lender is open to an OIC.
If the SBA approves your offer, your personal guaranty on the loan will be released. You will pay the amount agreed to in the offer, and this payment could be structured over time.
As you prepare your offer, you will also need to get your financial disclosures ready. Since the SBA needs to understand your “full financial capacity,” you’ll need to have ready prior years’ tax returns, a personal financial statement with a list of your assets, as well as other forms that the SBA will require.
The most critical part of your OIC is your grounds for acceptance of the offer. This is your argument to the SBA that they should settle with you rather than pursue the full amount of the debt. There are a few strategies that can result in the SBA accepting your OIC.
Demonstrate to the SBA that it cannot recover the debt in a reasonable amount of time. You must convince the SBA that your offer is a better option for recovering part of the loan. For example, a factor could be the amount of disposable monthly income you have compared to the loan amount.
This approach looks at the underlying SBA loan itself and raises questions about the SBA’s ability to prevail in court because of legal issues or factual disputes. An attorney would review the loan documentation and determine if there were issues with documentation, misrepresentation, or due process.
Offer in Compromise vs. Collection
The SBA will not settle if further collection efforts will recover more. You need to convince the SBA that your offer is better than what the federal government could otherwise obtain through home equity, wage garnishment, litigation, or other tactics.
This involves “crunching the numbers” and understanding the collection process so that you can make an offer that the SBA will find reasonable.
Using an Attorney for Your SBA Offer in Compromise
If your loan is facing default, the best option is to open discussions about options as soon as possible. Your willingness to work with the SBA and your lender will go a long way. The SBA offer in compromise is a way to make a good faith settlement on your business debt.
How much you will end up owing will ultimately depend on the amount of the debt and the package that you present to the SBA based on the strategy used.