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 on 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) brought Management Agreements back into focus and created an additional area of review to determine an applicant’s eligibility for SBA financing.

CFR 120.100(a) states “[t]o 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 agreement make the business passive?

In SOP 50 10 8, the SBA answered this question. The SBA states “[b]usinesses 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 further provides guidance in reviewing the Management Agreement, stating that the Borrower must be involved in all of the following in order for the applicant to have meaningful oversight of its business and make sure its operations align with the covenants of the SBA loan agreement:

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 applicant has meaningful oversight of its business, or whether the Management Agreement makes the applicant an ineligible passive business. Since determination of whether or not an applicant is an operating business goes to its eligibility for SBA financing, a wrong determination could result in a complete denial of the SBA Guaranty.  Lenders should keep a copy of the Management Agreement and their analysis of meaningful oversight in the loan file for SBA’s review.

If you have questions about Management Agreements, or SBA eligibility in general, consulting an experienced SBA compliance lawyer can help protect your guaranty. Please reach out to Starfield & Smith at: tdlauro@starfieldsmith.com.