SBA + Pari Passu Loan DSCR Test: Seeking Insights

December 25, 2024

by a searcher in New York, NY, USA

For those who have closed an SBA deal with a pari passu conventional loan, I could use your advice.

I just received the subordination agreement that the seller needs to sign, and it includes a DSCR (Debt Service Coverage Ratio) test. If the DSCR falls below a certain level, the bank has the right to suspend payments on the seller note. However, our lender has informed us that the DSCR is defined as (EBITDA - Distributions) / Debt Service. Essentially, any distributions to investors are subtracted from EBITDA in the numerator.

This is proving to be a tough pill to swallow because one of our key commitments to investors is a timely return of their capital. This construct makes it very challenging to distribute funds to our investors while remaining compliant with the DSCR covenant.

On top of that, I believe the bank is already well-protected through the SBA credit agreement, which prohibits distributions that could have an adverse impact on the business.

For context, this is the first time the bank is doing an SBA deal with a conventional loan, so I want to make sure this approach isn’t out of market or overly restrictive.

Have others encountered this DSCR definition or clause? If so, how did you manage it with your bank and seller? Any insights would be greatly appreciated!

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

Commercial loans typically limit distributions to equity holders until the debt is fully paid off or paid down to a certain level. With SBA loans, I was surprised distributions are allowed. So, I called SBA. Their answer was they leave distribution restrictions up to each lender. I am guessing that has to with PG from SBA perspective. However, if there is a preferred return, or a return of the capital, to those who are also considered part of the equity stack to meet SBA %, then sooner or later SBA is going wake up and limit distributions, or some lenders are going to limit that from day one. SBA deals are highly-levered-transactions (HLT) to begin with. We all know HLTs have created problems in the past with asset bubbles (e.g. CRA enforcement forcing banks to lower equity requirements for housing resulted in the asset bubble that popped in###-###-#### Allowing distributions to equity holders, in my mind, make SBA deals ultra-high HLT. Sooner or later the asset bubble will pop. If you can get by, go with it.

Reply by a lender
from University of Southern California in Los Angeles, CA, USA

Highly discourage you from working with a bank doing their first SBA pari passu deal. There is no upside and only downside. The subordination agreement is not standard unless the seller note is being used in lieu of an equity injection.

We work with all the major SBA lenders that can do pari passu deals. The bank pay us after your loan closes, so this is a 100% free service for you. You can reach me here or directly at redacted You can also click here to schedule a meeting with me: https://cal.com/ishan-jetley-3d73m8/30min. Look forward to chatting!

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