Best Practices: A Review of Equity Injection Requirements Under SOP 50 10 8

With the issuance of SOP 50 10 8, effective June 1, 2025, the SBA will be returning to well-established principles of equity injection.  The SBA has eliminated the “do what you do” component to equity injection which was established in SOP 50 10 7.1.  The Borrower once again will need to show that it has, “skin in the game.”  “To do this, the Lender (for PLP loans) or SBA (for non-delegated loans) must determine if the equity position, any required equity contribution, and the pro forma debt-to-worth are acceptable based on the factors related to the type of business, experience of management, and the level of competition in the market area.”  SOP 50 10 8 at p. 131.  After making this determination, the Lender will need to document its analysis in its credit memo.

The SBA has brought back minimum equity injection requirements for start-up businesses.  A start-up business is defined as a business that “has been in operation (i.e., generating revenue from intended operations) for 1 year or less.”  SOP 50 10 8 at p. 131.  The SBA requires a minimum equity injection for all start-up businesses of at least 10% of the total project costs defined as “all costs required to become operational.”  SOP 50 10 8 at p. 131.

The SBA continues to require minimum equity injection requirements for complete changes of ownership, i.e., changes in ownership resulting in a new owner.  When loan proceeds are used to fund a complete change of ownership, the SBA requires a minimum equity injection of 10% of the total project costs defined as “all costs required to complete the change of ownership, regardless of the source of funds.”  SOP 50 10 8 at p. 131.  A seller note may only be included as equity injection if it is on full standby for the life of the SBA loan and if it does not exceed half of the SBA-required equity injection (e.g. 5% of the 10% minimum equity injection requirement).

For changes of ownership between existing owners, i.e., complete partner buyouts, the SBA will allow less than 10% equity injection if the remaining owner(s):  (i) certify that they have been active in the business and have held the same or higher ownership interest for at least the preceding 24 months and (ii) the debt-to-worth ratio of the business is no greater than 9:1 prior to the change of ownership as shown on the balance sheets for the most recent fiscal year and current quarter.  If the Borrower cannot meet these conditions, the remaining owner(s) must contribute the lessor of a) cash to obtain a debt-to-worth ratio of no greater than 9:1 as shown on the balance sheet for the quarter prior to the change of ownership or b) cash of at least 10% of the business purchase price as shown in the purchase agreement.

For partial changes of ownership, the SBA will allow less than 10% equity injection if the debt-to-worth ratio is no greater than 9:1 prior to the change of ownership as shown on the balance sheets for the most recent fiscal year and current quarter.  If the Borrower cannot meet these conditions, the new and/or existing owner(s) must contribute the lesser of a) cash to obtain a debt-to-worth ratio of no greater than 9:1 as shown on the balance sheet for the quarter prior to the change of ownership or b) cash of at least 10% of the business purchase price as shown in the purchase agreement.

The SBA does not require a minimum equity injection for certain situations. These include: (i) loans to ESOPs purchasing a controlling interest in a small business (51% or greater), (ii) expansion loans for businesses in the same NAICS code and geographic area, (iii) loans to existing businesses for working capital or asset purchases, and (iv) loans for changes of ownership between existing owners and partial changes of ownership meeting the above-described conditions. However, lenders can still require equity injection if deemed prudent.

The SBA has provided a list of acceptable forms of equity injection. These include: (i) debt on full standby for the life of the SBA loan, (ii) unborrowed cash, (iii) cash from personal loans with outside repayment sources, (iv) grants without repayment or clawback requirements, (v) assets other than cash (with proper valuation), and (vi) verified prepaid expenses.

The SBA has eliminated the “do what you do” component for sourcing equity injection. Lenders are expected to use reasonable and prudent efforts to verify that equity is injected and used as intended, and failure to do so may warrant a repair or partial/full denial.  Lenders should retain in their file copies of checks and wire transfer, account statements showing available funds (at least 30 days), and settlement statements, paid invoices and account statements documenting the use of funds. Promissory notes or gift letters alone are not sufficient evidence. For borrowed funds used as equity injection, lenders must show an outside source of repayment.  Seller financing must be on standby or subordinated to the SBA Loan.

Changes to equity injection are just a few of the many welcomed changes set forth in SOP 50 10 8.   We will continue to analyze various aspects of SOP 50 10 8 in the coming weeks.

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