One of the critical requirements the lender should follow relative to the proper closing of a Small Business Administration (SBA) loan, is ensuring the use of proceeds are properly documented in accordance with the lender’s credit approval and the SBA Loan Authorization (Authorization). Documentation supporting the use of proceeds is highly scrutinized during an SBA audit, and errors are one of the most common reasons for a “repair” during a guaranty purchase – which is closely reviewed in connection with early defaults. Taking measures to properly document the use of proceeds can minimize costly loan guarantee repairs or even full denial of the SBA guarantee.
Lenders must disburse loan proceeds in accordance with the Loan Authorization. However, the SBA does permit the lender to disburse loan proceeds to the borrower as working capital even when the specific loan proceeds are not detailed within the Authorization as long as the amount does not exceed 10% of the specific purpose, or $10,000 (whichever is less).
If there is a required or requested change to the approved use of proceeds, the lender must submit a modification request to 7aLoanMod@sba.gov for approval by the SBA with detailed reasons for the proposed changes.
Both the lender and borrower must complete and sign SBA Form 1050 at the time of the first disbursement. It is the lender’s responsibility to document the first and all subsequent disbursements by attaching the required documentation to the original SBA Form 1050 and the lender must maintain the documentation in the loan file – following procedures described in SOP 50 10.
From this documentation, the SBA must be able to determine sufficient detail to support the following:
- The recipient of each disbursement;
- The date and amount of each disbursement; and
The purpose of each disbursement.
The following documentation is acceptable to verify disbursements in accordance with the Authorization:
- Joint payee checks
- Copies of receipts, invoices or other supporting documentation marked “PAID” by the seller or vendor
Evidence of an electronic funds transfer to a vendor along with a copy of the invoice
If the Authorization identified working capital as the use of proceeds and those proceeds will be used to pay normal operating expenses (e.g., payroll, utilities, etc.), the subsequent use of a working capital disbursement does not need to be documented.
Important Considerations for Lenders
- Lenders should review the Settlement Statement to ensure the use of proceeds coincides with the Authorization, (e.g., sale price, closing costs, seller verification, vendor verification, etc.). The lender should always obtain copies of checks, invoices and/or wire confirmations corresponding to the Settlement Statement and attach these documents to SBA Form 1050. All subsequent disbursements made post close should be documented similarly.
- Lenders should review payoff letters ensuring the letters are on the financial institution’s letterhead; and if wire instructions are provided, confirm the wire instructions are for the financial institution to be paid off.
- Lenders are cautioned that while SBA does not require verification of working capital proceeds, the SBA does monitor prudent disbursement. For example, if a loan approval includes twelve months of working capital as part of the approval, it would not be prudent to fully disburse all such funds at closing. Alternatively, lenders should consider disbursing working capital incrementally over the twelve-month period to decrease the likelihood of misuse by the borrower.
Perhaps the most important “take-away” for lenders is to remember that if the loan proceeds are not distributed in a manner consistent with the Authorization, the guaranteed amount may be repaired. A complete denial will result when an early default and/or improper use of proceeds cause the failure of the business. Ultimately, it is the lender’s responsibility to ensure the loan proceeds are properly disbursed.