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May 24, 2017

Best Practices: Eligible Uses of Proceeds for Renovations

by Michelle Sergent Kaas

The SBA limits what an eligible passive company (EPC) can do with SBA loan proceeds. An EPC must use loan proceeds to “acquire or lease, and/or improve or renovate real or personal property (including eligible refinancing) that it leases to one or more Operating Companies (OC) for conducting the OC’s business.” SOP 5010 5 (I), Subpart B, Chapter 2, § III(F). For an existing building, the EPC must lease 100% of the rentable property to an OC, and the OC can lease up to 49% of the rentable property to a third party. However, the EPC cannot use loan proceeds to improve or renovate any of the rentable property that the OC leases to a third party. SOP 5010 5 (I), Subpart B, Chapter 2, § IV(F).

Whether or not loan proceeds are being used to improve or renovate property that is leased to a third party is not always clear cut. What if the EPC is using loan proceeds to update a HVAC system, replace an alarm system, install an elevator or install a new roof? In determining whether these improvements/ renovations would be eligible for SBA loan proceeds, you will need to ask questions and document your file.

With regard to updating a HVAC system, could the work be split between the rented space and the OC space? If so, then the work done to the rented space would not likely be eligible for SBA proceeds. Is it a centralized system? If it would be impossible to upgrade only part of the system, then it is likely that proceeds for upgrading the entire system would be SBA eligible. What does the invoice reflect? Does the invoice break down the work by unit/suite number? If so, then the work done to the rented space would probably not be eligible to be financed with SBA proceeds.

With regard to replacing an alarm system, the focus would be on the collateral. If the work is necessary to protect the collateral, then it is likely that proceeds for replacing the entire alarm system would be SBA eligible.

With regard to installing an elevator, who will benefit from the work? If the OC maintains its business on the first floor and a tenant leases the second floor, then installation of an elevator to assist the tenant in hauling its equipment, products, etc., to the second floor would likely not be eligible. However, if the OC also maintains a storage facility on the third floor and needs an elevator to haul its equipment, products, etc. to the third floor, then proceeds for the elevator installation would most likely be SBA eligible.

What if the EPC is seeking to use SBA loan proceeds to install a new roof on property that the OC rents to a third party? Is the roof damaged? Could failure to repair the roof lead to further damage or compromise the structural integrity of the property? If the work is needed to protect the collateral, then it is likely that proceeds for the roof work would be SBA eligible.

For more information on using loan proceeds for renovations, contact Michelle Sergent Kaas at 267-470-1167 or at mkaas@starfieldsmith.com.