Applying for an SBA Loan? Get Ready to Buy Insurance

An SBA loan can provide much-needed funding if your business is in a pinch. Don't let insurance prerequisites delay your disbursement.

In the small-business world, cash is like oxygen. With a hard work ethic, sound business sense and a little luck, the sky's the limit to what you could accomplish in a few short years. But you won't make it far if you can't breathe.

The U.S. Small Business Administration (SBA) exists for this purpose—to help Americans obtain much-needed capital to start and grow their small businesses. The SBA guarantees a significant portion of loans that might otherwise be too risky for lenders to offer to small businesses. It's an important part of the U.S. economy, and it helps thousands of businesses obtain funding every year.

However, just because your loan is partially backed by the government doesn't mean your lender won't still do its due diligence to make sure they'll recoup their investment from you.

Before you obtain or receive any disburnment from your small-business loan, you'll need to submit proof to the SBA or your lender that you've satisfied all prerequisites. For example, depending on your business or industry, you may need to provide proof of the necessary licenses, a history of profitability or collateral to back your debt should you default on the loan.

One of the prerequisites you'll almost certainly have to provide is proof insurance.

Do I need insurance to get an SBA loan?

Whether you'll need to obtain insurance to qualify for an SBA loan could depend on a number of factors, including your location, your company's dependence on in-house stock or machinery, your health, and your company's dependence on your personal involvement to remain profitable.

Life insurance

Life insurance is not required by the SBA for every loan. However, the administration encourages lenders to require life or disability insurance if there is a reasonable concern that your business could not survive without you or a small group of employees. For example, let's say you're the founder and president of a garbage disposal company, and you need an SBA loan to enlarge your fleet of trucks. If you're not involved in the daily processes of the business, your death probably wouldn't prevent your business' employees from carrying on their work, so a life insurance policy might not be required.

However, if you run a small consultancy firm, for which you are the primary consultant, your death could mark the end of your business. In such a case, a lender would likely require you to take out a life insurance policy to cover the full amount and term of the loan.

If you already carry a large enough life insurance policy, a lender may also accept a collateral assignment of that policy's benefit in lieu of a new policy. However, the SBA stipulates that the lender should not be named as the beneficiary of the policy itself. Your insurer can provide the necessary forms to make this distinction.

Hazard and flood insurance

If your business—or any personal property listed as collateral on a loan—is located in a FEMA-designated special flood hazard zone, the SBA stipulates that a lender must require the borrower to purchase flood insurance. The policy must cover the replacement cost of the property or, if that's not possible, its full insurable value. The policy must also contain a mortgagee clause or lender's loss-payable clause that favors the lender.

If you fail to procure this coverage, you could be disqualified from obtaining any SBA loans in the future. However, if you're unable to obtain flood insurance coverage, or if coverage is prohibitively expensive in your area, you can ask your lender to request a waiver from the SBA, explaining why coverage is unobtainable.

As with flood insurance, any business or personal property relevant to the loan must also be insured against hazards, such as theft or fire. This includes any machinery, equipment or inventory listed as collateral on the loan.

Other types of insurance

In addition to life, hazard and flood insurance, you may also be required to provide proof of other forms of coverage, such as state-mandated workers' compensation insurance. This coverage could change based upon the nature of your business. For example, if you're operating a restaurant, the lender could require you to provide proof of host liquor liability insurance. If you're operating a chiropractor's office, you may need to provide proof of malpractice insurance.

Compare prices early to save

When you're operating a small business on a tight budget, you might not know you need a loan until you're desperate. In such a case, having a loan disbursement stalled because of a pending insurance policy could be disastrous. And if you're rushed in obtaining a policy, you might find yourself stuck with unfavorable rates due to a lack of homework on your part.

If you think your business might need a SBA loan in the near future, compare rates from a few insurance companies now to get ahead on the paperwork. You can easily obtain free quotes online by entering basic information. Doing so will help you find the best rates without stalling the disbursement of your loan in the future.

Daniel Caughill

Daniel is a Staff Writer at ValuePenguin, covering insurance, retirement and other personal finance topics. He previously wrote about compliance and best practices for K-12 school districts at Frontline Education.