Defaulted SBA loans are climbing, and the acquisition lending space is in flux. The SBA and lenders have taken notice and taken action.

For acquisition entrepreneurs and the investor class, the question is simple: what does all of this mean for your next deal?

To make sense of it, this issue summarizes a recent video breakdown from Ray Drew, a national SBA lender with 15 years of experience building teams, refining processes, and training other lenders on how to underwrite acquisition deals.

His view from inside the bank tells a story that every buyer should understand before they sign their next term sheet…

For most of Drew's career, the bulk of SBA 7(a) lending centered on real estate, which remains the program's largest use of proceeds. Business acquisition was always part of the mix, but it was a specialized corner of the market. Lenders who didn't understand it - no industry experience to underwrite against, no collateral to fall back on - simply passed on those deals.

That changed in 2021.

Drew moved to a lender comfortable doing larger, under-secured business acquisition loans right as the entrepreneurship-through-acquisition (ETA) movement exploded. Podcasts, influencers, and accelerators sprang up everywhere, and suddenly every SBA lender in town was an "acquisition specialist."

The timing lined up with a flood of cheap liquidity. Defaults were nearly nonexistent. Sellers posted record years and exited at valuations 10 to 20 times what they'd have fetched 18 months earlier.

The SBA leaned into the momentum and loosened the rules:

Meanwhile, social media glamorized and oversimplified the idea of buying a business. It looked, briefly, like free money.

Then the tide went out.

Rates climbed 5.25% over 18 months - a shock few were prepared for. Lenders typically stress-test deals against a 2% or 3% rate increase, not 5%. Supply chains cracked, wars broke out, and inflation set in.

As borrowers struggled, deferment requests poured in, and many of those deferments turned into defaults.

That's when the structural problem surfaced.

When there's no collateral, the SBA ends up subsidizing roughly 75% of the loss on a defaulted loan. Historically, those subsidies were covered by program fees paid by borrowers and lenders - not taxpayers. But the prior administration had waived fees on the vast majority of loans.

The result was a perfect storm, and for the first time in years, the SBA was losing money.

The losses prompted swift action:

The SBA put the guardrails back up, restoring credit standards and reinstating program fees almost immediately. As Drew points out, waiving fees sounds appealing in theory - until it threatens the sustainability of the entire program. For a moment, some in the industry genuinely weren't sure it would survive.

The equity injection rules came back, and new ones were added, including a 2-year personal guarantee for any seller retaining ownership. The updated SOP (Standard Operating Procedures) arrived with a letter that explicitly called out search funding.

A search fund is an investment vehicle through which an entrepreneur raises money from investors to acquire a company they'll then run day-to-day. According to the SBA, an emerging pattern troubled them: investors taking less than 20% ownership to dodge the personal guarantee requirement, then using a side agreement to hand effective control of the business back to the investor.

The SBA's position, as Drew summarizes it: if the guarantor doesn't have real control, the business is passive and ineligible. And if an investor requires specific returns over a set period, that's debt, not equity - and it has to be factored into the cash flow analysis.

None of this is technically new, Drew notes. What's striking is how clearly the SBA signaled its distaste for private-equity-style investors entering these deals. Reasonable people will debate it, but the program was never designed with that model in mind.

The crusade didn't stop there.

In March, Forbes reported that the SBA had quietly implemented a rule that effectively disqualifies investors from future SBA funds if a business they invested in defaults and the SBA takes a loss. And it wasn't limited to major investors… it appeared to reach any minority owner, even an employee granted a 2% equity stake.

The SOP states that an applicant is ineligible if it, or an associate, previously defaulted on a government-backed loan. But the SOP defines an "associate" as an officer, director, 20%-plus owner, or key employee. Nowhere does it say a 1% passive owner should be banned.

Yet in practice, Drew has personally hit this wall multiple times - submitting for an SBA approval number, getting an error code tied to a prior government loss, and having to remove minority owners from the cap table just to close the deal.

The update: On May 28th, after pushback from the ETA community, the SBA released a new policy notice allowing affected minority owners to request a waiver. There's significant nuance, and the SBA retains final say, but it's a path forward where there wasn't one before.

As Drew puts it, why ban a 1% owner of a business they had no control over?

The lender response is simple to predict. Just as the SBA pivoted when it started losing money, lenders pivot the same way.

As defaults doubled and tripled, virtually every SBA lender in the country tightened its credit box. Some of the largest acquisition lenders moved away from aggressive deals toward conservative, sustainable lending. Others exited the space entirely.

Walk into an SBA conference today and the theme is back to basics. Drew points to 3 areas drawing the most scrutiny:

The SBA has stated at these conferences that large, unsecured business acquisition loans are among the top drivers of recent losses - second only to small loans. Since the SBA regulates the banks, the banks fall in line.

Drew's read on where things stand is direct: the writing is on the wall.

The era of inexperienced buyers acquiring businesses at four-to-five-times trailing-twelve-month earnings with 5% down is over.

Here's what lenders increasingly want to see:

And the larger the loan with minimal collateral, the tighter those requirements get.

It's worth keeping perspective on the numbers. Business acquisition has always been part of SBA lending - historically about 20% of the program, spiking maybe 15 to 20% above that level at the peak. The real difference in performance was more about the buyer pool changing, driven by social media hype.

The takeaway isn't that buying a business is a bad idea. For the right buyer, it remains a fantastic one.

As Drew frames it, this is hard, but it's not rocket science...

SBA lenders are simply getting back to basics - and the old warning applies as well as ever: if it sounds too good to be true, it probably is.

Thanks for reading Acquiring & Exiting

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