Why SBA Loans Don’t Have Financial Covenants (And Why That Matters to Borrowers)
One of the most overlooked advantages of SBA financing—especially the SBA 7a loan program—is something most borrowers never think to ask about:
SBA loans typically do NOT have ongoing financial covenants.
That may sound like a small technical detail, but in the real world, not having financial covenants associated with your business loan can be the difference between comfortable/stable, long-term financing and a loan that becomes a problem at the first sign of a downturn.
What Are Financial Covenants?
For most conventional commercial bank loans, the borrower must meet certain financial tests every year (or sometimes every quarter). These are called financial covenants.
Common examples include:
- Minimum Debt Service Coverage Ratios (DSCR) (for example, 1.20x or higher)
- Maximum leverage ratios
- Minimum net worth requirements
- Minimum liquidity requirements
If the borrower fails one of these tests—even temporarily—the bank may have the right to:
- Declare a technical default
- Increase the interest rate
- Charge fees
- Require a principal paydown
- Freeze a line of credit
- Refuse to renew the loan
- Force a refinance or sale
All of this sounds a bit unlikely or even unfair, but the old adage of “he who has the gold, makes the rules” applies in this case.
I can remember speaking with a business owner I knew during the Great Recession who told me his loan was being called simply because his building (like most real estate) had dropped in value and he was no longer at the appropriate loan to value. He had never missed a payment and the bank called and said he had to come up with approx $500,000 to remedy the situation.
This was at a time when there was a massive amount of carnage in the financial system and the economy in general. Personal and business bankcruptcies were at an all time high and banks were actually failing and this guy’s bank wanted him to go find $500,000 somewhere to pay the loan down.
Crazy sounding? Yep. Real? Yep
Anyway, the key point about most conventional/bank loans is they have these covenants and while most of the time, they are not a problem, there are times that they very definitely create financial havoc – and it is typically at an inopportune time.
Why SBA Loans Are Different
SBA loans are underwritten based on the cash flow at the time of approval, not ongoing covenant compliance.
For most SBA 7a and SBA 504 loans, the lender underwrites the borrower’s repayment ability at closing and the loan is approved based on historical or projected cash flow.
Once the loan closes, there are generally no ongoing financial maintenance covenants tied to Debt Service Coverage, leverage, or liquidity as long as the borrower makes payments as agreed, and complies with the basic loan terms, then the loan typically remains in good standing.
You can learn more about the advantages and disadvantages of SBA 7a loans on our main site here: SBA 7a Loan Requirements
SBA Rules Regarding Covenants
According to the SBA underwriting rules, lenders must perform a thorough repayment analysis at loan origination, demonstrate that the borrower has adequate cash flow to repay the proposed debt and structure the loan so it is not likely to default.
What the SBA rules do not require is ongoing financial maintenance covenants like those commonly found in conventional bank loans.
Lenders may still require annual financial statements, monitor loan performance, and take action if payments are not made, but it would be really unusual for a borrower to be placed into default solely because some financial ratio was out of line. In fact, most banks and SBA lenders will bend over backwards to help business owners survive short term financial troubles.
No Covenants = No “Technical Default” Risk
Businesses rarely grow in perfectly straight lines.
Even strong companies can experience slower years, a temporary drop in margins, expansion costs, economic downturns and all of these can lead to issues with a conventional bank loan, because conventional bank loans almost always have covenants.
And, for conventional loans with covenants, a temporary financial glitch could lead to a covenant violation, put a loan into technical default or give a bank or lender leverage to change the deal.
With most SBA loans if payments are made on time, the loan stays in good standing.
Example: Conventional Loan vs. SBA Loan
Conventional Bank Loan
- DSCR covenant: 1.20x – possibly higher
If the business has a slow year, it could result in a technical default, an increase in rate, trigger a loan paydown or possibly even a forced refinance out of the bank – even if the borrower has made every payment on time.
By comparison, SBA Loans are underwritten at closing and have no ongoing covenants.
If cash flow dips temporarily, there is no technical default, no surprise rate increase, no loan paydown and no forced refinance.
Why This Matters for Business Owners
1) More Stability
SBA loans provide long-term, predictable capital without annual covenant tests.
2) Better for Growth-Oriented Businesses
If you are:
- Acquiring a business
- Expanding locations
- Building new facilities
- Investing heavily in equipment
Your cash flow may dip temporarily.
SBA loans allow that without triggering covenant violations.
3) Protection During Economic Downturns
In recessions, conventional banks often:
- Tighten covenant enforcement
- Reduce risk exposure
- Push borrowers to refinance or exit
SBA loans are designed to be:
- Longer term
- Fully amortizing (no balloons or short-term maturities)
- Less sensitive to short-term fluctuations
4) No Annual Re-Pricing Leverage
With conventional loans:
- Covenant violations often allow the bank to
- Increase rates
- Add fees
- Shorten terms
With SBA loans:
- Pricing is set at closing.
- There is generally no annual covenant test that allows repricing.
The Bottom Line
SBA loans are not just about lower down payments, longer terms and higher leverage. They also offer structural stability and the lack of financial covenants is a key reason why some business owners choose SBA financing—even when they qualify for a conventional loan.
Please get in touch if you have any questions about financial covenants and SBA lending or just SBA lending in general: jking (at) green commercial capital (dot) com or you can use this form on our website: contact Green Commercial Capital/John K