Changes in the SBA’s SOP – An Expert’s Guide Though the Maze (Part 2)
Having identified and examined changes to the Small Business Administration (SBA) Standard Operating Procedures (SOP) in Part 1 of this article series (published in December 2017), Part 2 will explore additional changes Innovative Financing Solutions believes both lenders and borrowers should understand when utilizing an SBA loan for their new and continuing financing requirements.
This article highlights additional important revisions in the new 410-page SOP 50 10 5(J) document (in addition to the changes outlined in Part 1), covering:
- Change of Ownership
- Credit Underwriting Standards
- Franchise Affiliation
Change of Ownership
Under the SOP, applicant(s) and co-applicants may use loan proceeds for a change of ownership, whether the change of ownership is accomplished through a stock purchase (including a stock redemption) or an asset purchase, under specific circumstances as outlined in the SOP. Additionally, an SBA-guaranteed loan cannot be made solely to an individual – the small business must be either the borrower or a co-borrower.
An important change to the SOP is that if the borrower will be acquiring the small business’s real estate in a separate transaction with a non-SBA guaranteed loan, the SBA loan must receive a shared lien position (pari passu) on the real estate with the non-SBA guaranteed loan (this provision does not apply if the business real estate is being financed as part of a 504 project).
Also noteworthy is that the seller may not remain as an officer, director, stockholder or key employee of the sold business. However, if a short transitional period is needed, the small business may contract with the seller as a consultant for a period not to exceed 12 months including any extensions. When the purchaser is an ESOP or equivalent trust and is acquiring a controlling interest (51 percent or more) in the employer business, the seller may stay on as an owner, officer, director, stockholder or key employee of the company; however, any seller who remains as an owner, regardless of percentage of ownership interest, must provide their guaranty in accordance with certain requirements of the SOP.
Credit Underwriting Standards
Credit underwriting standards for 7(a) loans greater than $350,000 and loans of $350,000 or less that do not meet the SBA’s minimum credit score requirements for 7(a) Small Loans require the lender’s credit analysis to address the applicant’s ability (and likelihood) to repay the loan from the cash flow of the business and past performance by documenting: (a) a full description and history of the business including the nature of the business; (b) length of time in business under the current management; and (c) depth of management experience in the related industry.
However, under the updated SOP, the SBA has added a few new requirements including: (d) the requirement to provide a brief description of the business’ management team including the principal’s involvement in the daily onsite management of the business or how the daily operations will be managed if the principals are not there on a daily basis, and (e) if the daily operations will be handled under a management agreement, the Delegated Lenders must (i) obtain a copy of the management agreement, review it and retain in their loan file; and (ii) Non-delegated lenders must submit a copy of the management agreement to the Loan Guarantee Processing Center (LGPC) with their application. We encourage readers to refer to Chapter 2, paragraph II.D.7 of this Subpart for further guidance on management agreements: (13 CFR § 121.301(f)(3))
The financial analysis for all applicants must address: (a) historical cash flow for existing businesses that demonstrates total debt service coverage after the SBA loan. If the historic cash flow does not show sufficient debt service coverage, the lender must obtain and analyze two years of detailed projections including the supporting assumptions from the applicant; (b) a calculation of operating cash flow (OCF) defined as earnings before interest, taxes, depreciation and amortization (EBITDA); and (c) justification for specific additions and subtractions to cash flow.
A noteworthy clarification to the SOP is that the applicant’s debt service coverage can be 1:1 on a global basis, whereas the global debt service requirement was previously unspecified and assumed to be 1.15:1. To perform a complete analysis of debt service, it is important for a lender to obtain a current debt schedule prepared by the applicant, including any shareholder debt.
Under the revised SOP, the SBA has also revised the review process for applicants for 7(a) and 504 loans that are or will be operating under a franchise, license, dealer, jobber, or similar agreement that meets the Federal Trade Commission (FTC) definition of a franchise.
Perhaps most importantly, under these changes, lenders and CDCs will no longer need to review franchise or other brand documentation for affiliation or eligibility.
New: SBA Franchise Directory
The SBA has created and is posting a list on its website of all franchise and other brands reviewed by SBA that are eligible for SBA financial assistance. The Directory includes only those brands that SBA has determined are eligible under SBA affiliation rules and other eligibility criteria. If the applicant’s brand meets the FTC definition of a franchise, it must be on the Directory in order to obtain SBA financing. This Directory will be maintained on SBA’s website and contains additional information. To review the Directory, we encourage readers to visit http://www.sba.gov/for-lenders
Under the new SOP, applications involving a franchise or similar relationship, lenders and CDCs must check the Directory to determine if it includes the applicant’s brand before submitting the application to the SBA for non-delegated processing or approving the loan under delegated authority. If the brand is on the Directory, the lender or CDC can proceed with processing the application. If the brand is not on the Directory, then the application cannot be processed. If the applicant’s brand is not on the Directory, the SOP sets out the procedures a franchisor must follow to request that SBA add its brand to the Directory.
For non-delegated loans, if the applicant’s brand meets the FTC definition of a franchise, the lender and/or CDC must identify the name of the franchise and the SBA Franchise Identifier Code when entering the application in E-Tran or SBA One. No other franchise documentation must be submitted to the appropriate processing center with the application. The processing centers will confirm that the brand is listed on the Directory.
For delegated loans, if the applicant’s brand meets the FTC definition of a franchise, the lender and/or CDC must document in its file that the applicant’s brand is on the Directory and identify the franchise and the SBA Franchise Identifier Code when entering the application in E-Tran or SBA One. The lender must submit the documentation showing the applicant’s brand is on the Directory with any guaranty purchase request.
When an Applicant operates under multiple brands, the SBA lender must identify the name of the franchise and the SBA Franchise Identifier Code for the brand that generates the largest amount of the applicant’s revenue when entering the application into E-Tran or SBA One. The SBA lender must identify all other brands the applicant operates under and their SBA Franchise Identifier Codes (if applicable) in the credit memorandum. For non-delegated loans, the SBA processing centers will confirm all brands critical to the applicant’s business operation are on the Directory. For loans processed under the SBA lender’s delegated authority, the SBA lender must document in its file that all brands critical to the applicant’s business operation are on the Directory.
It is critical that both lenders and borrowers fully understand the new SOP guidelines that went into effect on January 1, 2018. This article outlines updates to selected portions of the SOP, and we encourage readers to read Part I in this series (click here) to gain a clearer understanding of these revisions. For more information on SBA Lending and other government-guaranteed loan programs, contact the experts at Innovative Financing Solutions.