Best Practices: Partial Changes of Ownership on SBA Loans

On May 9, 2023, the SBA issued Procedural Notice 5000-846607 (“SBA Notice”) which addresses the implementation of SBA’s Final Rule on Affiliation and Lending Criteria for the SBA Business Loan Programs effective May 11, 2023 (88 FR 21074) (“New Rules”).  The SBA Notice revises the guidelines in the SOP 50 10 6 pertaining to different SBA program requirements.  One of those changes is that partial changes of ownership are an accepted Use of Proceeds for Standard 7(a), 7(a) Small and SBA Express Loans. This change is also reflected in the SOP 50 10 7, which will go into effect August 1, 2023.

The SBA Notice removed the requirement that all changes of ownership must be 100% complete change of ownership.  This is a significant departure from prior SBA policies and could open up many possibilities for new business acquisitions under the SBA 7(a) loan program. However, as with all SBA loans, the Lender still needs to ensure it follows SBA requirements and guidelines.

Lenders may now make SBA loans to a party only purchasing a portion of a small business provided they follow the new guidelines in the SBA Notice and the SOP 50 10 7,.  According to the guidance from SBA, the following conditions must be met for a partial change of ownership:

• Both the small business and the individual owner(s) who is acquiring the ownership interest in the small business must be co-borrowers on the SBA loan.
• If the small business is redeeming a partial ownership interest from one or more owners. All owners are subject to the requirements for guaranties under the SBA rules, including the 6 month lookback period (per the soon to be issued Technical Update to SOP 5010(7)), such as all 20% or more owners must provide a full, unlimited guaranty.

For ESOP transactions, there is a statutory requirement if the seller of the employer small business remains as a partial owner, the seller must provide a full, unlimited guarantee regardless of ownership – this statutory requirement cannot be waived.

In a partial change of ownership, the seller may remain as an owner, officer, director, stockholder, Key Employee, or employee of the business. The SBA guidance is silent on whether a seller in a full change of ownership may remain on as an officer, director or Key Employee, so Lenders should presume that the seller must fully exit the business as has been standard SBA policy for changes of ownership.

The SBA Notice also states clearly that all other policies and procedures for 7(a) changes of ownership remains in place.

In addition to the requirements set forth above, a partial change of ownership also creates specific equity injection requirements, as follows:

• 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 in ownership.
• In the event the Lender is unable to document the above is satisfied, the borrowers must contribute cash in the amount of at least 10% of the partial change of ownership purchase price, as reflected in the purchase and sale agreement.

Whether you are a new lender or a seasoned SBA lender, the partial change of ownership option is new for everyone and lenders should proceed cautiously throughout this process. As more of these types of loans are closed, we can expect further guidance from the SBA and additional questions and concerns to arise.  But for now, a lender must make sure that it not only complies with the new requirements, but that it closes the loans in a reasonable and prudent manner that also protects the SBA’s interests.

If you have any questions, feel free to contact Tim at tdlauro@starfieldsmith.com