Written by Live Oak Bank
The U.S. Small Business Administration (SBA) has implemented two Procedural Notices and new Standard Operating Procedures (SOP), which contain significant changes to the 7(a) and 504 lending programs. The 7(a) is the flagship program when financing change of ownership opportunities.
We’re breaking down the top things you need to know about the new SBA SOP and additional guidance here.
- Rules have changed around equity injection.
Equity injection is defined as new cash or other acceptable assets added to the project that is not on the borrower’s balance sheet prior to the equity injection.
Acquisitions: When purchasing a business that results in a new owner (complete change of ownership), the SBA requires an equity injection of at least 10 percent of the total project costs associated with the acquisition. Seller debt that is on full standby (meaning the seller is not accepting payment of principal or interest) or interest only, both for a minimum of 2 years can now be fully eligible as consideration for equity injection.
- Rules have changed for Employee Stock Ownership Plans (ESOPs).
Lenders that have delegated authority can now submit ESOP transactions as such. Additionally, loans to ESOPs for the purpose of purchasing a controlling interest (at least 51%) in the employer’s small business are not required to provide an equity injection.
- SBA is now allowing loans for partial changes of ownership.
SBA loans can now be used to fund the purchase of a portion of one or more owner’s interest in the business. Partial business acquisitions are now eligible through SBA loans, creating exciting opportunities for deal structures that benefit all parties involved. Additionally, for partial changes of ownership, the selling owner is allowed to “remain as an owner and involved in the day-to-day business, including as an officer, director, key employee, or employee.” Rolled equity from the target company into the new company for seller’s still remains ineligible.
- New SOP now allows for individuals to have an additional $3.75 million of guaranteed dollars.
The additional $3.75 million of guaranteed dollars is equivalent to a $5MM 7(a) loan, in additional eligibility if they are acquiring a business that is not in the same 3-digit NAICS subsector as any currently owned business with existing SBA debt in which the below apply:
- Businesses owned > 50% by the applicant business
- Businesses that own > 50% ownership of the applicant business
- Any businesses owned > 50% by this business that operate in the same 3-digit NAICS subsector as the applicant business
- When an individual owns > 50% of the applicant business, every business owned by that individual > 50% within the same 3-digit NAICS subsector as the applicant business
Historically, personal guarantors of SBA loans have had their existing personally guaranteed SBA debt included in the aggregate SBA exposure calculation.
- The SOP now specifically allows for buyer rebates.
Buyer rebates are allowed (i.e., seller proceeds held as escrow holdbacks tied to performance) that are released upon satisfactory business performance. While Seller Promissory Notes with performance-based covenants have always been allowed, this allows more flexibility on structure to make deals work. It is also a great tool to help mitigate specific risks such as concentration, employee retention, unproven growth trends, licensing considerations, supplier and customer transition, etc.
- Personal resource test is eliminated.
SBA Lenders no longer need to consider the personal resources of the loan applicant when applying for SBA loans. Historically an applicant for a business loan had to show that the funds requested were not available from personal resources, meaning all the borrower’s usable liquid assets were reviewed. Under the new rule, SBA lenders are not required to evaluate the personal liquidity of the applicant during the review process. This now allows stronger, more liquid borrowers to pursue the SBA financing route where previously they would have had only conventional low leverage, high equity options available. This will allow strong borrowers, who are looking to do multiple transactions over time, the ability to have reserves and injection for each project.
Lastly, through this new guidance, the SBA has also reduced the amount of documentation that lenders must collect to verify equity.