The 504 loan program is used to finance fixed assets for eligible small businesses, primarily costs related to the acquisition and/or improvement of real estate or other long-term fixed assets. However, under specific circumstances, a 504 loan can be used to finance a change of ownership, provided all other 504 loan program requirements, including job creation or retention, are met. These exceptions have been gradually introduced by the SBA over the past few years, and recently, there has been an increase in demand for this type of financing. Generally, there are two scenarios where changes of ownership are eligible for 504 financing: (1) a change of ownership between existing owners of an Eligible Passive Company (EPC), and (2) a change of ownership of a business through a stock or ownership interest purchase. SOP 50 10 7.1, pages 305-306.
- Change of Ownership Between Existing Owners of an EPC:
504 loan proceeds may be used to finance a change of ownership between existing owners of an EPC, but several significant conditions apply:
a. Asset Limitation: The EPC’s assets must be limited to real estate or other long-term fixed assets leased to an Operating Company (OC) for conducting the OC’s business.
b. Complete Acquisition: The purchasing owner must acquire 100% ownership of the EPC.
c. Ineligible Assets: If the EPC owns ineligible assets (e.g., tax or insurance escrows, capital replacement reserves, etc.), 504 loan proceeds may be used to finance the change of ownership only if:
i. The ineligible assets are directly related to the real estate or other eligible long-term fixed assets.
ii. The value of these ineligible assets is “de minimis” (though not defined in the SBA’s SOP).
iii. These ineligible assets are excluded from the project financing.
All these conditions must be met for the use of 504 loan proceeds to be eligible.
- Change of Ownership via Stock or Entity Ownership Interest Purchase:
Ownership interests in a business can include fractional ownership of shares in a corporation, membership units in an LLC, beneficial interests in a business trust, partnership interests, joint ventures, and others. 504 loan proceeds may be used to finance a change of ownership in any of these equity interests, provided the following conditions are satisfied:
a. Asset Limitation: Similar to the EPC exception, the business assets financed by 504 loan proceeds must be limited to real estate or other long-term fixed assets. Any excess value allocated to other assets (“excess value”) cannot be financed with 504 loan proceeds and must be of “de minimis” value. However, the excess value may be financed separately. Additionally, the assets considered to be of excess value, do not need to be directly related to the real estate or other long-term fixed assets.
b. Complete Acquisition: The change of ownership must result in the purchaser owning 100% of the business. Like in complete changes of ownership under other SBA business loan programs, the seller cannot remain as an officer, director, stockholder, or key employee of the business.
The SBA closely scrutinizes these deals for eligibility, reviewing the business’s balance sheet, historical asset allocation, and specific terms of the purchase agreement. When the change of ownership is between existing owners of an EPC, additional documentation may be required depending on the nature of the transaction, especially given that an EPC can take various legal forms or ownership structures (e.g., corporation, partnership, LLC, tenancy in common) with their own set of legal formalities.
For more information regarding changes of ownership under the SBA 504 Loan Program, contact the attorneys at Starfield & Smith at info@starfieldsmith.com or 215.542.7070.
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