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September 18, 2013

Best Practices: Early Default Loans and the Guaranty Purchase Package – Startups & Acquisitions

by Starfield & Smith

In a previous article (Best Practices: Early Default Loans and the Guaranty Purchase Package-Underwriting Issues), I discussed the SBA’s definition of an “Early Default” loan, the requirement that Tab 7 of the SBA’s 7(a) guaranty purchase package be completed when a loan is an “Early Default” loan, and the underwriting-related requirements of Tab 7 of the guaranty purchase package (the IRS tax transcripts and the lender’s credit memorandum). This article will discuss the business acquisition and startup-related requirements that must be addressed in Tab 7 for Early Default loans.

A business valuation must be included in Tab 7 if the loan funded a change in ownership. In connection with the preparation of the guaranty purchase package, the lender should review the business valuation to confirm compliance with SBA requirements in effect when the loan was originated, e.g., that an independent valuation was obtained if one was required, that the valuation was prepared for the lender (and not for the borrower), and that the loan did not finance an amount in excess of the business valuation. Any issues should be addressed prior to submission.

For both a change of ownership and startups, the lender must provide evidence of the making of any required equity injection prior to loan disbursement and, to the extent required under then-applicable SBA requirements, of the source of the equity injection. Examples of satisfactory evidence of injection include the following:

• Credit card receipts reflecting the purchased item;
• Paid invoices with vendor receipts or corresponding cancelled checks;
• Processed checks showing the back of the check, evidencing that the check was negotiated; and
• Settlement statements dated and signed by the borrower and closing agent, showing the injection.

The lender should review its injection documentation to verify that it shows that the full amount of the required injection was, in fact, injected, and that it meets the SBA’s documentation requirements in effect at the time when the loan was made.

Whether the source of the injection is required depends on when the loan was made. As set forth on Tab 7, (i) if the loan was approved between September 6, 2005 and October 1, 2010, evidence of source is required if the amount of the required injection was greater than the lesser of (a) 1/3 of the loan amount or (b) $200,000; and (ii) if the loan was approved after October 1, 2010, evidence of source is required regardless of the amount of the required injection.

Evidence of source includes borrower bank statements that show the beginning and ending balances, reflecting the availability of the funds. While the SOP currently requires two months of Bank Statements, best practices would include obtaining bank statements for the month of closing and the two prior months. In situations where there is a significant gap in time between the original bank statement showing the availability of funds and the loan closing, however, we recommend that bank statements be obtained for all months, from the first statement through closing, to show that the funds that were available at origination were no longer available at the time of closing.

If Standby Agreements were required as a part of the borrower’s equity injection, they must be included in Tab 7. A copy of the note evidencing the standby debt must be attached to the Standby Agreement. Lenders should note that Standby Agreements are not required to be submitted when they were not part of the equity injection. Thus, if the SBA Loan Authorization did not specify that the standby debt constituted equity injection, but instead called for a Standby Agreement to put on standby debt that was otherwise owed to the holder of the standby note, that Standby Agreement may be omitted.

For more information regarding guaranty purchase requirements, contact Amy at 215.542.7070 or at abrownstein@starfieldsmith.com.