Best Practices: SOP Updates on Partial Changes of Ownership

One of the most drastic (and possibly most appreciated) changes to the SOP 50 10 7.1 was the addition of the ability to finance partial changes of ownership. This appears to be a highly utilized structure now that it is available and it provides small businesses with much needed options to finance transitions in ownership. In Procedural Notice 5000-852522, SBA further developed the partial change of ownership guidance, now outlining how it can be utilized in a multi-step structure.

Prior to the issuance of the Procedural Notice, partial changes of ownership required that equity interests of the selling owner be purchased directly by existing or new owners. The new provisions allow for a small business to be purchased through a new entity, where the ownership of the new entity is split between new owners and remaining owners of the existing entity.

To demonstrate this, assume this hypothetical involving the transfer of ownership of Small Business, Inc.

• Small Business, Inc. is owned 40% by Person A, 50% by Person B, and 10% by Person C.
• Person A wants to sell its interest in Small Business, Inc. to Person Y.
• The parties wanted to form a new entity, DEF, LLC.
• DEF, LLC will be owned 40% by Person Y, 50% by Person B and 10% by Person C.

There are certain conditions that need to be met in order for this structure to be eligible. For starters, the new entity must own 100% of the small business. So in our example, DEF, LLC would need to be structured as outlined above and would need to hold 100% interest of Small Business, Inc.

Also, the loan proceeds must not exceed the amount of the valuation that applies to the amount being purchased. So the loan proceeds in our example could not exceed 40% of the business valuation because only Person A’s portion of Small Business, Inc. is actually being sold.

The operating entity and the new owner must be co-borrowers on the loan. In our example, Small Business, Inc., Person Y and DEF, LLC would all need to be co-borrowers. However, what is not clear from the guidance is whether DEF, LLC may acquire the assets of Small Business, Inc. or must only accomplish the partial change of ownership by acquiring the stock of Small Business, Inc.

It is critical to remember that these structures are not available to be used in an EPC/OC transaction. So Small Business, Inc. cannot be an EPC or OC in this loan. Also, all guaranty requirements in the SOP apply to post-transaction ownership. Here, Person Y is already a co-borrower, so they would not also need to provide a guarantee. Person B would need to provide a guarantee because of their post-transaction ownership in Small Business, Inc. is more than 20%.

These transactions are also subject to the same equity requirements as other partial changes of ownership. So the business balance sheet must demonstrate a debt to worth ratio of no more than 9:1 prior to the change of ownership OR cash contributions to the purchase price of the partial change of ownership must be made in accordance with the current guidance.

For questions regarding partial changes of ownership, contact the attorneys at Starfield & Smith at 215-542-7070 or email us at info@starfieldsmith.com.