SBA Lending - The New Standard Operating Procedure & the Changes to Be Aware Of
As of August 1st, 2023, the new Standard Operating Procedure (“SOP”) for SBA lending (Small Business Administration Loan Programs) went into effect. There were many changes in the new SOP which impacts the SBA lending programs quite substantially. And as with any government related program, not all of the changes have been fully flushed out yet. Almost daily different interpretations and guidance have been released regarding many of the key changes, which is making it very hard for lenders to implement the changes. Below is a summary of many of the key changes we think most SBA Borrowers will want to focus on along with some feedback of how they are actually being implemented and any on-going interpretations or discussions impacting their implementation.
You can now do partial buyouts of businesses and sellers can stay in the business indefinitely. However, one key feature of these partial buyouts is that the buyer must be buying the stock or membership in the existing company. You cannot do an asset purchase under the partial buyouts. Instead, the seller keeps a percentage of the existing equity and the buyer acquires whatever percentage of the equity they are looking to acquire. There is no minimum stated in the SBA SOP of the percentage of the company someone must buy, but I think most lenders will want the loan to be $350,000 or higher to be worth the paperwork.
On a partial buy-out anyone who has a 20% or greater ownership interest in the selling company post-closing will be required to sign a personal guarantee. This includes any seller if their individual ownership is 20% or greater. In addition, if the loan is not fully secured by business assets, then all guarantors, including the seller(s), would be required to pledge equity in personal assets to shore up the collateral position if they have any such assets. However, many lenders have informed me that they might still want the seller to guarantee the loan or sign a partial guarantee even though they will own less than 20% of the business if they are seen as a key employee by the lender (maybe the buyer has no industry experience) or the seller controls a license vital to the operations of the business going forward. The SBA is still clarifying whether they might require guarantees from sellers retaining a 20% or lower interest post-closing.
There is no equity required by the SBA on partial business buyouts if the balance sheet of the seller is at a 9 to 1 debt to worth ratio in the year-end and quarter-end prior to closing. However, this does not mean lenders will not require equity down even if these ratios are met. If those ratios are not met, the equity to be required down by the SBA is 10% and is based on the percentage of the business being acquired.
If you operate a company now and are buying another company that is in the same NAICS code as your existing business, you can finance 100% of the business purchase via an SBA 7A loan. Some lenders were doing this prior to the new SOP, but the new SOP makes this a standard rule.
If you are buying out other owners in a company where you are already an owner, you have to have been an owner for the last 24 months. No equity is required if the balance sheet meets a 9 to 1 debt to worth ratio in the year-end and quarter-end prior to closing. If that condition is not met, then an equity injection of 10% is required by the SBA on the buy-out.
Seller debt can now be used as equity in both full and partial business acquisitions based on the new SBA rules if the seller note is on full standby for at least 24-months. The minimum equity requirement of 10% has not changed. However, this new rule means you can technically finance 100% of the business acquisition via the SBA loan and with a 10% seller note on standby for only 24-months. If the standby seller note requires interest payments during the first 24 months, then the new rule states the buyer must put down at least 2.5% equity and then the seller note can still count for the other 7.5% of the normally required 10% equity. Keep in mind, with the higher level of financing and the seller notes in place, the debt will still need to hit normal qualifying debt service coverage ratios for this type of financing to be allowed. In my discussions with lenders, this is one provision I think few lenders are going to move forward with. Prior to this change, the SBA allowed 5% down with a 5% seller note on fully standby. Many lenders would not use the 5% / 5% option and those that did only usually used it for very strong deals where the cash flow was very strong, the buyer had strong industry experience, or maybe the buyer was an employee buying out the seller with direct business experience. Some lenders have stated they will consider the 2.5% or possibly 100% financing in some of those same circumstances where they would have required 5% / 5%, but most lenders have indicated they are still going to require equity in on transactions from the buyer. In addition, you may still see lenders require seller notes on full standby for a longer period of time or more equity required down to make the cash flow work.
Technically no equity is required for a start-up business under the new SOP. However, most lenders we have spoken with have stated they will still require a minimum amount of equity, usually 10%, when doing business start-up financing.
The definition of "Affiliate Businesses" for SBA purposes has changed. This does not reduce related SBA exposure you have on any other transactions you have guaranteed, but now if you have less than a 50% ownership in other businesses the lender is no longer required by the SBA to get the financial statements on those entities and include them in the SBA underwriting.
The SBA franchise directory has gone away so Banks can make their own determinations as to what franchises they will lend to. Before this change all franchise loans could only be made to approved SBA franchises.
The SBA has tightened up the Tax Transcript Verification requirements even further. If tax transcripts cannot be received to reconcile with the applicant’s information, the loan must be cancelled, or the closing must be postponed until the issue is resolved. If lenders do not receive a response from the IRS or a tax transcript within 10 business days, the SBA lender may proceed to close the deal but if the information cannot be reconciled at a later date, then the lender might have an invalid guarantee. There are exceptions for when a division of a company is being purchased versus a whole company.
The Personal Resource Test is changing. Under the old test if any Guarantor had substantial liquidity (usually more than the loan amount), the loan would not pass the test and would be ineligible for SBA financing. That test is going away and lenders now have the ability to do a standard “Credit Elsewhere” test where they determine if the loan would readily qualify for standard commercial loans, which is a test required on all SBA 7A loans to begin with. If the loan does not qualify for “Credit Elsewhere”, then they can still make the loan regardless of the liquidity of any one guarantor.
These changes were largely made to increase the availability of capital to business owners and open the door for more business owners to transition their businesses. I believe the new rules for business acquisition financing work to allow buyers who may not have proper licensing to retain a previous owner with that license until they can secure that license themselves. I also think the new rules are going to open up businesses that might have been hard to sell in the past because much of the revenue is driven by the owner / seller, to provide an opportunity to bring someone in to learn the business and eventually take it over. Overall, I think partial business acquisitions are going to present an opportunity for growth going forward.
The SBA loan programs continue to service borrowing needs where traditional banks loans just do not work due to a higher degree of loan risk (start-up, expansion or challenging industry), where there is limited money to put down, there is not sufficient collateral to fully support the loan, or where a longer amortization is needed. Although some SBA lenders have pulled back slightly due to some market or industry concerns, overall SBA lenders are still aggressively lending and we do not expect a meaningful pullback in SBA lending regardless of economic conditions going forward.
If you would like to learn more about SBA loans or see if there is a product that would be a good fit for you, please just reach out to us at any time at 630-988-4852 or at brad@commerciallendingx.com.