SBA’s "One Strike" Rule May Reshape Self-Funded Search Investing

This Week in ETA:

Historically, anyone personally guaranteeing an SBA loan who went delinquent or defaulted was barred from future SBA financing - most of us know this well. But recently, we learned the SBA may have expanded that restriction to minority investors who are not signing guarantees and have no operational control. The SBA has not explicitly shared this, but rather we saw this firsthand. The SBA told the bank our bank that 100% of beneficial owners cannot include anyone who participated in past SBA-backed deals that went bad. In fact, we had to remove two small investors from our fund who’s previously been minority investors on SBA deals that defaulted in order to close the deal.

Apparently, an ETRAN update now doesn’t distinguish between majority owners/operators and minority investors when applying eligibility rules. If true, even investing $1 in an SBA deal that fails could permanently ban someone from future SBA participation, including LPs in funds investing in SBA-backed deals.

If this is true, minority investing in SBA deals becomes dramatically riskier. Even investors willing to take that risk may be banned for life after a single deal goes wrong. Since SBA equity investment is most prevalent in larger deals ($1M+ EBITDA), the practical effect could shrink the buyer pool on these deals, lower multiples, and favor only well-capitalized buyers capable of funding the full equity injection themselves.

There are also broader implications: self-funded searchers could lose real, value-add investors, and we can expect alternative deal structures to emerge to work around SBA guarantees. Clarity from the SBA will dictate the path forward, but if this “one strike and you’re out” rule is real, it could reshape self-funded search investing forever. It probably has the net effect of shrinking the buyer pool, especially for $1m+ EBTIDA deals. This in turn probably reduces multiples in that section of the market, which favors buyers who can put together non-SBA deal structures.

At Entrepreneurial Capital, we are (1) escalating this issue to the SBA to confirm if these changes are intentional, and (2) actively working to help searchers put together non-SBA deal structures, including by helping them find non-SBA lenders. We have a number of non-SBA deals in our investment pipeline, and will probably end up doing a webinar soon to share with the broader community how non-SBA deals are getting done, and why they can actually be even more attractive, on a risk-adjusted basis.

Partner Perspective:

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Plus:

• Matthias Smith at Pioneer Capital Advisory created a working capital calculator that leverages AI to help you calculate an estimate to include in your deal model.

• Fellow ETA Investor Adam Markley shared his comments on the potential implications of the SBA’s changes.

Question:

Hit reply and tell us - If you’re under LOI on an SBA deal that will need meaningful investor equity (and might need to pivot to non-SBA debt as a result), let us know, we’d love to try and help you find alternative debt sources.