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August 5, 2015

Best Practices: Succession Plans

by Janet M. Dery

When underwriting a loan for a startup business or a change in ownership, an SBA Lender has many different issues to consider. The Lender must evaluate the Borrower’s creditworthiness and decide whether or not lending money to the Borrower is an acceptable risk. As part of this evaluation, a Lender should determine the risk of the Borrower’s inability to repay the loan if a principal becomes unable to run the business due to permanent disability or death.

This determination is easiest for the Lender if the Borrower’s principal(s) have already addressed this issue with their insurance or financial advisor(s) and established a succession plan. Such a succession plan can include (i) buy-sell agreements between principals or between principals and key employees, (ii) life insurance policies than can be used to finance buy-sell agreements or payoff the loan, (iii) disability insurance policies, which can provide income while the principal is disabled for repayment of or payoff of the loan or until a sale of the business, and (iv) business expense insurance, which reimburses the principal for business expenses in the event that he/she is disabled and cannot pay them because of a decrease in income due to disability.

If there is no succession plan in place and the business is run by multiple principals, then the Lender should evaluate whether the death or disability of any one of them would affect the continuation of the business or its ability to repay the loan. If the Lender determines there is such a risk, it can mitigate the risk by requiring the collateral assignment of disability insurance and/or life insurance to provide a source of funds to continue to repay or to payoff the loan. To assist in determining the amount of disability insurance to require, taking into account the nature of the business, the Lender should estimate how long it would take to sell the business. The disability insurance amount can then be based on the number of months multiplied by the monthly loan payment. In respect to life insurance, the Lender can factor the amount and type of collateral available to repay the loan into the determination of the appropriate life insurance amount.

If the Borrower is run by only one principal (e.g. sole proprietor, single shareholder corporation, single member LLC), then a more thorough evaluation of the risk to continuation of the business or payoff of the loan is required, and the Lender may be required by the SBA to include a collateral assignment of life insurance as a condition of the loan.

Under SOP 50 10 5(H), if an SBA 7(a) loan exceeds $350,000 for a business run by one principal, life insurance is required for such individual in an amount consistent with the size and term of the loan, with the amount and type of collateral available to repay the loan taken into consideration in the determination of the appropriate life insurance amount. If it is determined that said principal is uninsurable at commercially reasonable terms, the Lender must obtain written documentation of the principal’s inability to be insured from a licensed insurer for its credit file.

Lenders make a critical decision when determining whether lending money to the Borrower is an acceptable risk. By addressing the issues discussed above, Lenders can better determine and mitigate the risk of non-payment of a loan due to the disability or death of a Borrower’s principal. For more information on succession plans and SBA life insurance requirements, contact Janet at jdery@starfieldsmith.com¬†or at 267-470-1189.