SBA SOP 50 10 8.1, B.Ch4.C.2 — Underwriting

2. Underwriting a. Lender’s Credit Analysis: The Lender’s credit memorandum and analysis must address the Applicant’s ability and likelihood to repay the loan from the cash flow of the business and past performance by documenting the following:

i. A description and history of the business, including: a) Nature of the business; b) Length of time in business under current management; c) Depth of management experience in the industry or a related industry; d) Brief description of the business’s management team including principal’s involvement in the daily onsite management of the business or how the daily operations will be managed if the principals are not there on a daily basis. e) If the application involves a franchise (as defined by FTC), the Lender must review any credit information provided, such as the number of failed franchisees and cash flow projections provided by the franchisor). Lender must review any management agreement (unless the management agreement is part of the franchise disclosure documents for a brand listed on the Franchise Directory) to determine if it results in an ineligible passive company;

ii. Financial analysis of repayment ability: a) For existing businesses based on the three most recent years of historical financial information (tax returns or balance sheet with debt schedule and income statement) plus an interim financial statement. (13 CFR § 120.191) b) For new businesses, based on detailed projections, including the supporting assumptions which reflect positive cash flow within 2 years. c) The financial analysis for all Applicants must address the following as applicable: i) Historical cash flow for existing businesses, that demonstrates total debt service coverage after the SBA loan; if the historical cash flow from the most recent full year and the interim financial statements do not show sufficient debt service coverage, Lender must obtain from the Applicant and analyze 2 years of detailed projections including the supporting assumptions justifying relying on projections instead of historical performance; ii) Calculation of operating cash flow (OCF) defined as earnings before interest, taxes, depreciation, and amortization (EBITDA); iii) Justification for additions and subtractions to cash flow such as the following: (a) Unfunded capital expenditures; (b) Non-recurring income; (c) Expenses and distributions; (d) Distributions for S-Corp taxes; (e) Rent payments; (f) Owner’s Draw; and/or (g) Global cash flow analysis that includes assessment of impact on cash flow to/from any affiliate business. iv) The effect any affiliates may have on the ultimate repayment ability of the Applicant.

iii. Debt Service (DS) is defined as the future required principal and interest payments on all business debt inclusive of new SBA loan proceeds. The Applicant’s debt service coverage ratio (OCF/DS) must be equal to or greater than 1.15 on a historical and/or projected cash flow basis and 1:1 on a global basis. To perform a complete analysis of debt service, it is important for a Lender to obtain a current debt schedule prepared by the Applicant, including any shareholder debt.

iv. For cash flow projections, the Lender must calculate the debt service coverage and provide the assumptions supporting the projected cash flow coverage, including as applicable: a) Justification for revenue growth, i.e., new product lines, sales channels, and new production facilities; b) Justification for any reduction in expenses; and c) A comparison to current industry trends.

v. Spread of pro-forma Business Balance Sheet (current business balance sheet adjusted for all changes in assets and liabilities as a result of the SBA loan, other debt, any required equity injection and use of loan proceeds);

vi. Ratio calculations (based on the pro-forma Balance Sheet and historical and projected Income Statements) for the following financial ratio benchmarks: Current Ratio, Debt/Tangible Net Worth, Debt Service Coverage, and any other ratios the Lender considers significant for the business/ industry (e.g., inventory turnover, receivables turnover, and payables turnover, etc.) including discussion of Lender’s comparison to industry trends;

vii. Analysis of working capital adequacy, at a minimum over the next 12 months;

viii. Insurance Requirements, including: a) Life Insurance – on whom and how much. If life insurance will not be required, provide justification. b) Business hazard & liability insurances.

ix. Explanation of and justification for the refinancing of any debts as part of the loan request, along with supporting documentation, in accordance with the debt refinancing requirements in Appendix 14. In addition, Lender must include a written explanation for any late payments over the past 12 months.