Best Practices: SOP 50 10 5 (J) and Its Updated Equity Injection Requirements

If you’re a Small Business Administration (“SBA”) lender, add to your list of New Year’s resolutions becoming familiar with Standard Operating Procedure (“SOP”) 50 10 5 (J). Announced October 16, 2017, SOP 50 10 5 (J) becomes effective January 1, 2018. SOP 50 10 5 (J) includes substantive changes to the SBA’s equity injection requirements for applicants financing start-up businesses and/or changes of ownership.

Pursuant to SOP 50 10 5 (J), applicants financing a start-up business will be required to inject “at least ten (10) percent of the total project costs to be necessary for [the] start-up business to operate on a sound financial basis.” Id. at pg. 174. The requirement that a start-up business inject 10 percent of the total project costs applies for all 7a loans regardless of the loan size. The requirement that start-up applicants inject 10 percent of the total project costs is a change from recent versions of the SOP. Currently, there is no minimum equity injection requirement for start-up businesses and lenders have the discretion to determine the appropriate amount of equity injection.

Similarly, borrowers financing a complete change of ownership will also need to inject a minimum of 10 percent of the total project costs. See id. However, per the revised SOP, when a change of ownership occurs between existing owners:

the pro forma equity position [of the remaining owner(s)] after the change of ownership must be at least 10 percent of the total assets. Otherwise, the remaining owners(s) must provide an additional equity injection that will result in no less than a 10 percent net worth of total assets. Id.

Lenders are advised to adequately document the value of the borrower’s assets when calculating its net worth and corresponding equity requirement. While the new SOP imposes no minimum equity requirements for real estate acquisitions, prudent lending dictates that a reasonable equity injection should be considered.

SOP 50 10 5 (J) also redefines what is eligible equity injection. Beginning January 1, 2018, seller financing may only qualify as equity injection if “[the seller debt] is on fully standby for the life of the SBA loan and [the seller debt] does not exceed half of the required equity injection.” Id. Prior to SOP 50 10 5 (J), seller debt could be counted as equity injection so long as it was subordinate to the SBA financing and on standby for the first two (2) years of the SBA loan. Lenders are still required to obtain SBA Form 155 (or lender’s equivalent Standby Agreement) with a copy of the Seller Note.

Additionally, SOP 50 10 5 (J) removes the requirement for PLP processed loans that an applicant financing a change of ownership and acquiring $500,000 of intangible assets inject twenty-five (25) percent of the total project costs. In lieu of the 25 percent equity injection requirement, lenders must adhere to the 10 percent equity injection rules discussed above.

As with all SBA lending, the SOP establishes the minimum requirements for what is needed to preserve the government guarantee. Lenders remain welcomed – if not encouraged – to require applicants to inject funds in excess of what is required by the SOP when circumstances warrant.

For help keeping your New Year’s resolution and other questions regarding SOP 50 10 5 (J), contact us at (215) 542-7070 or at info@starfieldsmith.com.