October 12, 2016

Best Practices: A Refresher on Source of Equity Injection

by Jessica L. Conn

For SBA lenders, proving equity injection is a critical part of the due diligence process since failure to properly do so can result in a denial of the guaranty. With that in mind, below are some tips on avoiding common pitfalls related to equity injection documentation.

SOP 50 10 5 (H) requires that lenders obtain the following documentation:

  1. “A copy of a check or wire transfer along with evidence that the check or wire was processed showing the funds were moved into the borrower’s account or escrow;
  2. A copy of the statements of account for the account from which the funds are being withdrawn for each of the two most recent months prior to disbursement showing that the funds were available; and
  3. A subsequent statement of the borrower’s account showing that the funds were deposited or a copy of an escrow settlement statement showing the use of the cash” [SOP 50 10 5 (H), pg. 164].

By way of example, assume that a borrower issues a check for a deposit on a real estate purchase on September 28, 2016. The funds aren’t withdrawn until October 5, 2016. In this instance, the bank should obtain the August, September and October statements to show that the funds were available when the check was cashed.

When looking at the bank statements, remember that one of the core purposes of equity injection is to demonstrate that the borrower has “skin the in game.” Therefore, SBA is looking to see that the funds being injected into the project are, in fact, borrower’s funds. In order to do this, lenders must obtain bank statements to support each deposit and look beyond the starting and ending balance to see what funds were available in the account.

For starters, lenders should ensure that the banks statements are for the accounts that were actually used for the equity injection. Borrowers will sometimes provide statements for several accounts, claiming that aggregately the funds were available and, therefore, they have proven the injection requirement. This is acceptable as long as the lender can track the transfer of funds from one account to another to show source. This is not acceptable if the statements generally show availability of funds, but the equity actually came from a different account (e.g. a home equity line of credit, if unable to show an outside source of repayment). Therefore, always insist on tracking the actual accounts used, rather than generally showing availability of funds from related, but unused accounts.

Next, Lenders should be looking to see if there are any deposits into the accounts that would suggest that the source of these funds is a party other than the borrower or principal of the borrowing entity. Generally this means that when reviewing banks statements, lenders should be looking for large deposits. SBA has not provided guidance on the specific size of a deposit that requires further review. Lenders should consider the type of account and industry to determine what deposits will need to be sourced and which will not. If the account used is an operating account and it is clear that the deposits (even if they are large) are customer payments, then no further documentation is typically needed to prove source. If the deposits are not from a readily identifiable source, such as customer payments, further inquiry should be made into the source of the funds. If the funds are transferred from an account of an affiliate of the borrower, the lender should obtain a statement from that account to determine the source of the funds. If the funds were borrowed by the principal of the applicant, the lender should obtain documentation showing that the principal has a source of repayment unrelated to the operation of the subject business (including salary of the principal). If the funds were gifted from another party, the lender should obtain a gift letter demonstrating that the funds are not borrowed as well as documentation showing the source of the funds.

It is critical that a lender retain all required documentation to prove equity injection in its file as a failure to do so can result in a repair or denial of the guaranty.

For more information on equity injection requirements, please contact Jess at or at 267-470-1188.