Best Practices: Criteria for Evaluating Management Agreements

One of the benchmarks of the SBA loan program is that SBA loans are made to operating small businesses and not passive entities. If a small business enters into a Management Agreement with a third party to assist with running its business, it presents a grey area for Lenders as to whether the business would be considered a passive business not eligible for SBA financing. Historically, Lenders looked at a Management Agreement to determine if it created an affiliation between the third-party manager and the small business, which would impact size determination and cap of financing for the small business. Since SBA’s final rule change in 2023, which removed affiliation by contract, some Lenders stopped considering whether a Management Agreement creates an eligibility issue for their applicant. However, SOP 50 10(8) brings Management Agreements back into focus and requires Lenders to review Management Agreements for control in order to assess whether a small business is active or passive.

CFR 120.100(a) states “To be eligible for an SBA business loan, a small business applicant must…be an operating business (except for loans to Eligible Passive Companies).”  When a business enters into a Management Agreement, it begs the question- does this now make the business passive?

In SOP 50 10 8, the SBA answers this question. The SBA states “Businesses that have entered into a Management Agreement with a third party that gives the management company sole discretion over the business operations are ineligible passive businesses. However, if the management company does not have sole discretion to manage the operations of the business and the Applicant exercises meaningful oversight of the business, the Applicant is eligible.”

The key phase is “meaningful oversight.”  The SOP defines it as “involvement in the decisions made concerning the operation of the business.”  Working with an SBA compliance attorney can help lenders evaluate Management Agreements thoroughly and avoid eligibility pitfalls under SOP 50 10 8. If there is a Management Agreement, it should state that Borrower must be involved in all of the following in order for the business to be eligible:

a. Approval of annual operating budget;

b. Approval of capital expenditures or operating expenses over a significant dollar amount;

c. Control over bank accounts; and

d. Oversight over the employees operating the business (who are employees of the Borrower).

It is the Lender’s responsibility (unless the Management Agreement is part of a franchise disclosure document that has been approved and placed on the SBA Franchise Directory) to review the Management Agreement to determine whether the Management Agreement makes the Borrower an ineligible passive business. The Lender should not take this responsibility lightly. Determination of whether an applicant is an operating business goes to their eligibility for SBA financing. Misclassifying a business as active when it is deemed passive could ultimately trigger SBA loan liquidation, putting both the borrower and the lender at risk. A wrong determination on eligibility could result in a complete denial of the SBA Guaranty. If you have questions about Management Agreements, or SBA eligibility in general, please reach out to Starfield & Smith at: info@starfieldsmith.com.