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January 3, 2018

Best Practices: Ramifications of recent changes to the EPC/OC Rule

by Victor A. Diaz

Newly promulgated regulatory changes to the Eligible Passive Rule (“EPC/OC Rule”) took effect on September 20, 2017. Among them was a rather simple and welcomed change, allowing the use of proceeds to finance a change of ownership between the existing owners of the EPC. The new SOP 50 10 (J), slated to become effective on January 1, 2018, incorporates the change in the rule and adds further guidance when financing a change of ownership between existing owners of an EPC.

Under general SBA principles, a Small Business Applicant may use loan proceeds to finance a change of ownership, whether the change of ownership is accomplished through a stock purchase, stock redemption or purchase of assets. Of key importance in structuring a loan used to finance the change of ownership is whether the change is between existing owners or whether the change of ownership will result in a new owner. Furthermore, in changes of ownership involving the sale of stock, it is equally crucial to ascertain whether an existing owner is purchasing the stock of a departing shareholder or whether the small business is redeeming the interest of a departing shareholder. Applying these to changes of ownership in an EPC, these rules will help determine who should be a borrower, co-borrower or guarantor of the proposed credit facility.

Changes of Ownership Between Existing Owners of the EPC

In a change of ownership where existing owners are purchasing the stock of a departing shareholder, the company whose stock is being acquired and the individual owners of the company must be co-borrowers. Additionally, the individuals acquiring the ownership interest and the company must be jointly and severally obligated under the Note. This language was not changed in the latest version of the SOP. Must all remaining individual owners, regardless of percentage of ownership, become co-borrowers even if they are not themselves acquiring any additional stock as a result of the change of ownership? This particular section on the SOP was not revised and further guidance is expected from the Agency on this issue.

Change of Ownership Through Redemption of the EPC Stock

Conversely, the section in the new SOP dealing with redemptions was modified. Going forward, in changes of ownership where the small business is redeeming the ownership interest of a departing shareholder of an EPC, the small business must be the borrower and all remaining owners, regardless of the percentage of ownership interest, must be either co-borrowers or guarantors. Prior versions of the SOP only suggested that remaining owners may be co-borrowers or guarantors. The language in the new SOP mandates they must be co-borrowers or guarantors. While not set forth in the SOP, the Agency has suggested that the guarantee may be limited to the remaining owners’ interest in the EPC.

Consequently, when financing changes of ownership between existing owners of an EPC, whether through stock purchase or redemption, the best practice is to require all remaining owners of the EPC, irrespective of their ownership interest, to be: (i) co-borrowers in stock purchase transactions; (ii) and co-borrowers or guarantors in stock redemption transactions. For any further questions, please contact Victor at vdiaz@starfieldsmith.com at 407-618-0694.