Many SBA Borrowers provide equity injection in the form of qualified rollovers of their existing 401(k), profit sharing plan or other qualified retirement account (collectively referred to herein as QRAs). To document this form of equity injection, lenders must conduct a unique analysis.
Lenders must first be able to identify a QRA rollover. In a rollover scenario, the QRA purchases some percentage of the borrowing entity’s stock. If the QRA owns at least 20% of the borrowing entity, pursuant to SBA regulations, it must provide a guaranty. By definition, QRAs cannot provide guarantees. To document the waiver of the QRA guaranty, the QRA must meet all applicable IRS eligibility requirements. In addition, SBA requires that the following conditions be met:
- a) The owner(s) of a 401(k) must provide his or her full unconditional personal guaranty regardless of the individual ownership interest in the applicant concern. This guaranty must be a secured guaranty if required by SBA’s existing collateral policies.
b) If the QRA is an ESOP, the members of the ESOP are not required to personally guarantee the debt, but all owners of the Small Business Applicant who hold an ownership interest of 20% or more outside the ESOP are subject to SBA’s personal guaranty requirements.
c) The application cannot be structured as an EPC/OC. (13 CFR §120.111(a)(6)) (SBA regulations require each 20% or more owner of the EPC and each 20% or more owner of the OC to guarantee the loan, and the regulation does not provide for an exception.)
Guaranty waivers are ineligible if: (i) the QRA purchases the stock of an EPC, as noted above, or (ii) the borrowing entity is an S-corporation. Provided none of the ineligible scenarios exist, lenders must next confirm that several requirements are met. Most importantly, individual owners must pay for their stock in an amount that is commensurate with their ownership percentage. In other words, the price per share paid by individuals must be equal to the price paid by the QRA for its shares, and the resulting ownership interests must be proportional to the price paid. Lenders should verify these amounts with the professional firm that orchestrates the QRA rollover and confirm that the funds were deposited in the C-corporation’s bank account. Secondly, if an individual’s spouse has any entitlement to the benefits of the QRA, he or she must provide a full unlimited guaranty. Lastly, an individual’s guaranty must be secured if the value of the business assets securing the loan is less than the amount of the loan.
Lender should document its file with the following information:
- An opinion letter from plan counsel confirming the QRA meets SBA requirements citing the relevant Internal Revenue Code (“IRC”) provisions and describing why the QRA cannot take on any liability;
- A copy of the letter from the IRS to the QRA processing company stating that the QRA is acceptable under the IRC
- A copy of all issued stock certificates for the borrowing entity to include the stock issued to the QRA
- Federal Employer Identification Number for the QRA
- Copies of all statements showing the rollover of funds and purchase of stock.
Lenders should encourage borrowers to consult with the appropriate tax and financial advisors so that any QRA formed for the purpose of a SBA loan is formed properly and in compliance with all applicable laws and regulations. An ineligible QRA may result in an ineligible loan and jeopardize the SBA guaranty.
Jen is an attorney with Starfield & Smith’s commercial lending practice group. Please contact us for legal assistance and guidance with SBA lending compliance matters. For more information, contact Jen at email@example.com.