Best Practices: SBA Requirements for Purchasing a Division of an Existing Business

SBA 7(a) loan proceeds may be used for a change of ownership. In many business acquisitions, the buyer purchases all of the seller’s assets. However, that is not always the case. There are times when a buyer agrees to purchase only a division or a segment of an existing business. This article examines when the purchase of a division or segment of an existing business could be eligible for SBA 7(a) financing.

There are several factors to examine when a 7(a) Lender is presented with a sale involving the purchase of a division or a segment of an existing business. The 7(a) Lender must determine if it can obtain acceptable, and verifiable, financials. “For a change of ownership, the SBA Lender must verify the seller’s business tax returns or a sole proprietor’s Schedule C. For 7(a) loans, when there is an acquisition of a division or a segment of an existing business, other forms of verification acceptable to SBA may be used in lieu of the IRS Form 4506-[C] (e.g. Sales tax payment records).” SOP 50 10 6 at p. 204. Other than sales tax records, the SOP is silent on what other forms of verification can be used to substantiate the seller’s financials. 7(a) Lenders may want to start by obtaining the balance sheets, debt schedules and income statements for each division and compare them to seller’s tax returns. This is done to determine what is being purchased and to confirm that the buyer is not purchasing a sinking division and/or that the seller is attempting to sell the dead weight out of the business.

7(a) Lenders will also need to determine if the change of ownership “promote[s] the sound development and/or preserve[s] the existence of a small business.” SOP 50 10 6 at p. 233. The 7(a) Lender needs to provide “[a]n analysis as to how the change of ownership will promote the sound development and/or preserve the existence of the business. If the analysis cannot support that the change of ownership will be in the best interests of the business and its continued, successful operations, the loan is not eligible for an SBA guaranty.” SOP 50 10 6 at p. 235. In the sale of a division or a segment of an existing business, the 7(a) Lender will need to examine not only what is being purchased, but what is being left behind.

As an example, let us assume that an existing business has two locations, and that the seller has an agreement to sell one of the locations and plans to keep the other. Let us also assume that the seller operates the business under one business entity and files only one tax return encompassing both locations. The 7(a) Lender would want to request sales tax payment records, balance sheets, debt schedules and income statements for each location and examine them to determine if the financials clearly identify each location and confirm that the location being purchased can support the SBA loan payment. In this scenario, it must appear that the change of ownership will preserve both locations and promote the development of the business.

There are also times when it may be impossible to adequately segment a seller’s financials or accurately determine what impact the sale of a division or segment of the business will have. It may also be difficult for 7(a) Lenders to know what financial information may be sufficient to the SBA and/or whether the sale of the division or segment is in the best interest of the business. Sales tax payment records and/or separate balance sheets, debt schedules and income statements may not be available. For these reasons, 7(a) Lenders often submit these loans for general processing. By submitting the loan for general processing, the 7(a) Lender takes away the guess work and obtains assurance from SBA that the loan meets SBA’s credit criteria.

For assistance with SBA lending matters, contact the attorneys at Starfield & Smith, PC at 215.542.7070 or visit us at www.starfieldsmith.com.