Personal Finance

These restrictions on coronavirus loans may surprise business owners

Key Points
  • The Small Business Administration has approved $38 billion in Economic Injury Disaster Loans for 430,000 borrowers.
  • EIDL restrictions around collateral, business structure and use of funds may surprise some business owners.
Closed signs hang on a fast food restaurant amid the coronavirus pandemic on April 24, 2020 in New York City, United States. COVID-19 has spread to most countries around the world, claiming over 196,000 lives with over 2.8 million cases. (Photo by Alexi Rosenfeld/Getty Images)
Alexi Rosenfeld

A type of loan for small businesses impacted by the coronavirus pandemic comes with restrictions that may catch some entrepreneurs by surprise.

Loans made through the Economic Injury Disaster Loan program, which was recently expanded by lawmakers, carry terms that may cause business owners to inadvertently default on their loan in the future, experts said.

And in the mad scramble to access federal funds and keep their businesses afloat, entrepreneurs who were approved for the EIDL program may not have carefully reviewed the provisions, experts said.

While terms may be familiar to larger businesses that sought loans, some fear they won't be as clear to small-business owners, who often finance operations with credit cards and credit lines instead of loans, said Brooke Lively, the president of Cathedral Capital, which serves as a CFO for small businesses.

They may also be unsuspecting given the relatively short and straightforward loan application, she said.

'Brave new world'

"You're running a $50 million company, you've seen this before," Lively said. "You're running a $3 million company, this is a brave new world you've entered without knowing it.

"There's nothing that's so onerous about the EIDL loan terms in general," she added. "It's just that, it's not the type of loan most small businesses encounter."

The $2.2 trillion coronavirus relief law enacted in March — the CARES Act — extended financial aid to small businesses through various loan programs.

One measure expanded the EIDL program, overseen by the Small Business Administration, by giving a loan advance of up to $10,000 to small-business owners. Applicants don't have to repay the advance.

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The SBA has issued nearly 430,000 disaster loans worth $38 billion to small business impacted by Covid-19 through the program, which has been plagued by delays, a dearth of funding and application restrictions.

That funding is in addition to $511 billion issued through the Paycheck Protection Program, which offers forgivable loans to small businesses.

EIDL terms

Unlike PPP loans, disaster loans — which carry a term of 30 years and a 3.75% interest rate — require a personal guarantee and are backed by collateral for loans exceeding $25,000. Loans are capped at $150,000. (The SBA recently reduced that from a $2 million cap.)

Loan collateral can include tangible and intangible property like inventory and equipment. Borrowers can't sell, lease, license or transfer collateral without prior approval from the SBA.

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Let's say a printing company wants to sell an old printer and buy a new one. It would need written permission from the SBA to do so, if the old printer is among the items collateralizing the disaster loan, Lively said.

Collateral also can't be used primarily for personal, family or household purposes. For example, those with company-owned cars that are also used for personal reasons could run afoul, Lively said.

Business owners also need SBA approval to reorganize, merge, consolidate or somehow change ownership or business structure. This could, for example, include bringing in or removing a business partner, Lively said.

EIDL funds can also only be used as "working capital" related to economic injury after Jan. 31. They can't be used as capital for physical improvements, for example, according to Javier Martinez, a partner at law firm Haynes and Boone based in Dallas.

For example, a restaurant hoping to use funds for an expansion or improvement to a building — patios, drive-through windows or plexiglass between booths to facilitate social distancing, let's say — wouldn't be able to do so, Martinez said.

Borrowers risk defaulting on their disaster loan if they breach these terms — meaning, among other things, that the loan would become immediately payable.

Using certain collateral may also breach any existing lending arrangements business owners have, Martinez said.

Without the lender's consent — say, a bank offering a line of credit secured with personal property — on the SBA lien, borrowers may violate that existing agreement, Martinez said.

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