Lenders extending Small Business Administration (“SBA”) loans have now been operating under SOP 50 10 5 (J) since January 1, 2018. As most SBA lenders are aware, SOP 50 10 5 (J) included substantive changes to the SBA’s equity injection requirements for loans involving start-up businesses and/or changes of ownership. For a full discussion of these changes, refer to an article titled “SOP 50 10 5 (J) and Its Updated Equity Injection Requirements” published on November 1, 2017 which can be found at https://starfieldsmith.com/article/best-practices-sop-50-10-5-j-and-its-updated-equity-injection-requirements/.
In SOP 50 10 5 (J), the SBA requires a minimum equity injection of “at least ten (10) percent of the total project costs…for a start-up business to operate on a sound financial basis.” Total project costs is defined as “all costs required to become operational, regardless of the source of funds.” Similarly, in change of ownership transactions resulting in a new owner, SBA also requires an equity injection of at least ten (10) percent of the total project costs. Total project costs for change of ownership projects is defined as “all costs required to complete the change of ownership, regardless of the source of funds.” For a discussion of change of ownership between existing owners, see the article mentioned above.
What if an applicant already owns a business (“Entity A”) and wants to expand its business by either purchasing another similar business or opening a new location? The applicant’s plan though is to form a new entity (“Entity B”) for the expansion to keep accounting and financial records separate for each location. Would SBA still require a minimum ten percent equity injection? It depends. SBA may consider this scenario to be an expansion rather than a change of ownership or start-up if the following criteria are met:
- Both Entity A and Entity B are co-borrowers on the proposed loan;
- Both Entity A and Entity B have identical ownership; and
- Both Entity A and Entity B businesses are in the same industry
Although SBA may not require a minimum of ten percent equity injection for an expansion, lenders must still consider whether a “sufficient invested equity” is required in order to reasonably assure repayment of the loan. Lenders should include a detailed discussion of their equity analysis in the credit write-up for each loan.
Lenders must be aware of the latest equity injection requirements and must follow such guidelines and adequately document equity injection in their files in order to avoid a repair or denial of the lender’s SBA guaranty. For more information regarding the SBA’s equity injection rules, contact Katie at 267-470-1207 or at firstname.lastname@example.org.