SBA Limits on Owner Salary and Distributions
By Alan Miklofsky | October 24, 2024

Small business owners often grapple with the complexities of managing cash flow while fairly compensating themselves for their time and investment. For businesses financed by Small Business Administration (SBA) loans, the situation becomes even more nuanced. SBA loans offer valuable funding, but they come with specific restrictions regarding how much owners can draw from their businesses. This article explores SBA guidelines for owner salary and distributions, why they exist, and how business owners can remain compliant while sustaining their personal financial needs.

Understanding SBA Loan Requirements

The SBA provides financial backing for loans primarily to encourage business growth and sustainability. Since the loan is government-backed, the SBA has a vested interest in ensuring the business succeeds and can meet its loan obligations. One way the SBA achieves this is by placing limits on how owners compensate themselves to ensure the loan funds are used responsibly.

While the SBA doesn't directly set an exact limit on owner salaries or distributions, loan agreements often include covenants or stipulations to prevent excessive payouts that could jeopardize the business’s financial stability. Lenders may impose specific guidelines, and failure to adhere can lead to loan default or legal repercussions.

Salary vs. Distributions: Key Differences

It's essential to distinguish between salary and distributions.

• Salary refers to the regular, predetermined compensation an owner receives for their active role in running the business, such as a CEO’s paycheck.

• Distributions involve the withdrawal of profits beyond regular salaries, often from retained earnings or net income.

Both salary and distributions are legitimate ways for business owners to benefit from their investment. However, lenders scrutinize both to ensure these withdrawals align with the company's ability to meet debt obligations.

SBA Guidelines on Salary and Distributions

Though SBA rules can vary by lender, some general principles apply across the board:

1. Reasonable Salary
   The SBA expects business owners to draw a "reasonable" salary, based on industry standards, experience, and the business's financial condition. What constitutes a reasonable salary can differ depending on the size, sector, and location of the business. For example, a retail store owner would be expected to draw less than the CEO of a larger enterprise.

2. Restrictions on Excessive Payouts
   SBA loan covenants may prohibit excessive distributions that could impair the company’s working capital. Distributions taken at the expense of cash reserves required for payroll, inventory, or debt repayment are red flags. Lenders often specify that owners must prioritize loan payments over discretionary distributions.

3. Loan Funds for Business Purposes Only
   SBA loans are intended for working capital, equipment, or other operational needs—not personal expenses. Using loan proceeds directly for owner compensation is generally prohibited. Even indirect misuse through excessive salaries or distributions can be viewed as non-compliance.

Balancing Compliance with Fair Compensation

For business owners, balancing personal income with SBA compliance can be challenging. Below are practical tips to ensure that owner compensation aligns with SBA expectations:

• Document Salary Decisions
  Base salaries on objective factors, such as comparable roles in the industry and your experience level. Maintain records to justify these figures in case the lender requests clarification.

• Retain Earnings for Stability
  Avoid withdrawing large distributions too soon. Building up retained earnings demonstrates financial prudence and reassures lenders of the business's long-term viability.

• Work with an Accountant
  Consulting with an accountant familiar with SBA loans ensures your salary and distributions align with industry norms and loan requirements.

• Create a Compensation Plan
  Develop a formal plan that details your salary and distribution strategy for the year. A written plan demonstrates professionalism and can help prevent impulsive decisions that may violate loan covenants.

Navigating Exceptions and Adjustments

There may be times when adjustments to salary or distributions are necessary, such as during economic downturns or business booms. In such cases, transparency with the lender is crucial. If cash flow tightens or business conditions change, notifying the lender and requesting temporary adjustments may be possible. Lenders prefer proactive communication over discovering non-compliance after the fact.

Conclusion

SBA loans can be a powerful tool for business growth, but they come with responsibilities. Managing owner salary and distributions within the guidelines of SBA loans ensures business stability and avoids conflict with lenders. Striking the right balance between personal income and company health is key to long-term success.

With proper planning and a disciplined approach, business owners can enjoy the benefits of their hard work without compromising their business’s financial integrity—or their standing with the SBA.

By understanding these limitations and working proactively within them, small business owners can protect their personal and business interests while staying on the path to success.