Best Practices: Updated Guidance on SOP 50 10(5)(J)

UPDATE:  This article has been revised to reflect clarification provided by SBA on determining whether a minimum equity injection is required for a partner buyout.

On April 3, 2018 SBA issued Policy Notice 5000-17057.  It provides guidance on different matters related to SOP 50 10 5(J) which became effective on January 1, 2018.  Two significant matters addressed in the Policy Notice are modifications to (i) Credit Elsewhere analysis for owners (their spouses and their minor children) of the Applicant and (ii) Equity Injection for partner buyouts.

Under the new guidance, when determining an Applicant’s access to credit from a non-Federal source related to the Applicant, a Lender must analyze the liquidity of all owners of 20% or more of the Applicant. The threshold for this credit elsewhere analysis was previously 10% or more owners of the Applicant under the SOP 50 10(5)(J).  This is a welcome revision for Lenders because it creates consistency with the Lender’s requirement to obtain personal financial statements for all 20% or more owners of the Applicant for the loan application.

This change to the credit elsewhere test means that Lenders no longer need to be concerned with modifying their credit underwriting policies to collect and review financial statements for individuals and entities with less than 20% ownership in the Applicant.  However, the challenge that remains for the Lenders is to ascertain when an owner’s liquidity causes the credit elsewhere test to fail disqualifying the Applicant for SBA financing.

The Policy Notice also provides new guidance regarding minimum equity injection for partner buyouts.   SOP 50 10(5)(J), Section C.1,b, ii. b) ii (page 174), required that a partner buyout must result in a pro-forma equity position after the change of ownership of at least ten percent (10%) of the total assets, or the remaining owner(s) must provide an additional equity injection that will result in at least a ten percent (10%) net worth (maximum pro forma debt-to-worth ratio of 9:1).

The Policy Notice replaces the guidance for minimum equity injection for partner buyouts for 7(a) Loans (both under and over $350,000).  Under the Policy Notice, when an Applicant intends to use 7(a) loan proceeds to finance more than 90% of the purchase price of a partner buy out, Lender must perform the following analysis:

1. Remaining owner(s) must certify that they have been actively participating in the business and held the same ownership interest for at least the past twenty four (24) months (Lenders must include in the credit memorandum confirmation of this certification and retain evidence in the loan file); and
2. The business balance sheets for the most recent completed fiscal year and current quarter must reflect a debt-to-worth ratio of no greater than 9:1 prior to the change of ownership.

If a Lender is unable to document both steps (1) and (2) above, the Lender must require that the remaining owner(s) provide cash injection in the amount of at least ten percent (10%) of the purchase price of the business.

In addition to the guidance on credit elsewhere and the minimum equity requirements for partner buyouts discussed in this article, the Policy Notice provides guidance regarding businesses that are involved with cannabis, as well as clarification on monitoring of Working Capital Caplines.

For more information on the Policy Notice 5000-17057, or SBA credit underwriting requirements. Please contact Kimberly Rayer 267-470-1208 or at krayer@starfieldsmith.com.