I previously posted updates on the SBA 7A loan program set to go into effect August 1st, ###-###-#### However, an updated Procedural Notice was released by the SBA in May that made many of the changes effective immediately. This post is an update to the previous post with those changes and a few other additions. It looks like the changes are mostly permanent at this point, and even though the new SBA Standard Operating Procedure ("SOP") does not go into effect until August 1st, 2023, most of the changes are now already in effect.
One point of clarification I would like to make. Even though the new SOP allows some things, it does not mean the lenders are going to fully adopt all the provisions of the new SOP. What I mean by this is that many lenders will continue to keep more stringent underwriting and credit standards such as requiring more equity in deals, additional seller notes, etc. that are deal specific (much like many do now) to reduce their risk, even though the SBA SOP allows them to be more aggressive. Because of this it is important to understand individual lenders policies as it relates to SBA lending.
I have had discussions with many of our lending partners on how they plan to handle some of these changes, and I have summarized some comments below related to what I have been hearing from lending partners related to each change.
Here are the major changes impacting business acquisition financing.
1) Already in effect, you can now do partial buy-outs of businesses and sellers can stay in the business indefinitely. However, one key feature of these partial buyouts is that the buyer must be buying the stock or membership in the existing company. They can buy that interest via another company they own and include investors, but ultimately the selling company will stay in place and be the primary borrower. You cannot do an asset purchase under the partial buy-outs or do a true "equity-roll" where the seller sells 100% of the interest of the company to a new company and then becomes a partner in the new company. Instead, the seller keeps a percentage of the existing equity and the buyer acquires whatever percentage of the equity they are looking to acquire. There is no minimum stated in the SBA SOP of the percentage of the company someone must buy, but I think most lenders will want the loan to be $350,000 or higher to be worth the paperwork. Based on discussions with lenders to date, just about all lenders plan to adopt funding partial buy-outs.
2) Already in effect, on a partial buy-out, anyone who has a 20% or greater ownership interest in the selling company post-closing will be required to sign a personal guarantee. This includes any seller if their individual ownership is 20% or greater. In addition, if the loan is not fully secured by business assets, then all guarantors, including the seller(s), would be required to pledge equity in personal assets to shore up the collateral position if they have any such assets. If you are a buyer, it is going to be important for you to discuss this issue with sellers up front, as I doubt many sellers are going to want to sell 60 to 80% of their business and still have to guarantee the loan. Please note if the seller retains less than 20% of the business post-closing, they will not be required by the SBA to personally guarantee the loan, which also means they will not be required to pledge outside assets to back the loan as that is only a requirement for guarantors with a 20% or greater ownership interest. The guaranty requirements for sellers is not something lenders can change. However, many lenders have informed me that they still might still want the seller to guarantee the loan or sign a partial guarantee even though they will own less than 20% of the business if they are seen as a key employee by the lender (maybe the buyer has no industry experience) or the seller controls a license vital to the operations of the business going forward. But if they own less than 20% of the company and are required by the lender to sign a full or partial guarantee on the loan, they would not be required to pledge outside collateral on the loan according to the SBA rules.
3) Already in effect, there is no equity required by the SBA on partial buy-outs if the balance sheet of the seller is at a 9 to 1 debt to worth ratio in the year-end and quarter-end prior to closing. However, this does not mean lenders will not require equity down even if these ratios are met. If those ratios are not met, the equity to be required down by the SBA is 10% and is based on the percentage of the business being acquired. So, if someone is buying a 70% stake in a business valued at $1 million, the required equity injection would be 10% of $700,000 or $70,000. Most lenders have informed me that they will consider doing deals with no equity required from the buyer but it is going to be deal specific and is more likely to happen for smaller percentage purchases where the seller is guarantying the loan. If it is a buyout of most of the company, it appears most lenders will likely require some sort of equity contribution from the buyer, and I would plan on that equity being 10%.
4) Already in effect, if you are buying out other owners in a company where you are already an owner, you have to have been an owner for the last 24 months. No equity is required if the balance sheet meets a 9 to 1 debt to worth ratio in the year-end and quarter-end prior to closing. If that condition is not met, then an equity injection of 10% is required by the SBA on the buy-out. Most lenders were already operating under this or a similar rule and most lenders have indicated they will continue to offer this option so long as the cash flow works at 100% financing.
5) Already in effect, if you operate a company now and are buying another company that is in the same NACIS code as your existing business, you can finance 100% of the business purchase via an SBA 7A loan. Some lenders were doing this prior to the new SOP, but the new SOP makes this a standard rule. Most lenders have indicated they will be offering 100% financing on these transactions so long as the cash flow works at 100% financing.
6) Already in effect, seller debt can now be used as equity in both full and partial business acquisitions based on the new SBA rules if the seller note is on full standby for at least 24-months. The minimum equity requirement of 10% has not changed. However, this new rule means you can technically finance 100% of the business acquisition via the SBA loan and with a 10%seller note on standby for only 24-months. The use of seller notes for equity used to require the note to be on full standby for the life of the SBA loan and the seller note could only count for 5% of the required equity still requiring 5% in borrower equity, so this is a big change. If the standby seller note requires interest payments during the first 24 months, then the new rule states the buyer must put down at least 2.5% equity and then the seller note can still count for the other 7.5% of the normally required 10% equity. To summarize, the SBA will now allow no money down with a 10% seller note on full standby for 24-months or the SBA will only require 2.5% down with a seller note having interest only payments for 24-months. Keep in mind, with the higher level of financing and the seller notes in place, the debt will still need to hit normal qualifying debt service coverage ratios for this type of financing to be allowed. In my discussions with lenders, this is one provision I think few lenders are going to move forward with. Prior to this change, the SBA allowed 5% down with a 5% seller note on fully standby. Many lenders would not use the 5% / 5% option and those that did only usually used it for very strong deals where the cash flow was very strong, the buyer had strong industry experience, or maybe the buyer was an employee buying out the seller with direct business experience. Some lenders have stated they will consider the 2.5% or possibly 100% financing in some of those same circumstances where they would have required 5% / 5%, but most lenders have indicated they are still going to require equity in on transactions from the buyer. In addition, you may still see lenders require seller notes on fully standby for a longer period of time or more equity required down to make the cash flow work.
7) Already in effect, for underwriting partial buy-outs, seller salary can only be added back if the seller is no longer going to have a permanent role in the company (beyond a one-year transition). If the seller is staying active, the seller can provide notice they are taking a reduced salary as part of the purchase to add-back any difference in salary. But this is something that will need to be figured out with each individual transaction. Lenders have indicated this is how they will handle this.
8) Already in effect, the definition of "Affiliate Businesses" for SBA purposes has changed. This does not reduce related SBA exposure you have on any other transactions you have guaranteed, but now if you have less than a 50% ownership in other businesses the lender is no longer required by the SBA to get the financial statements on those entities and include them in the SBA underwriting. Some Banks have stated they will no longer include non-affiliate businesses in underwriting where some have stated they may still include them in the global cash flow depending on percentage of ownership, even though it is no longer required by the SBA.
9) Effective 8/1/23, the franchise directory will go away so Banks can make their own determinations as to what franchises they will lend to. Before all franchise loans could only be made to approved SBA franchises. Lenders still seem to be determining how they will handle this change.
10) Already in effect, the Small Loan Advantage program has been permanently increased to $500,000 from $350,000, making it easier to qualify for smaller balance loans.
11) As always, the SBA loan cannot exceed the business valuation for the company you are buying or the percentage of the company you are buying. So, if you are buying 70% of a business for $700,000, the whole business must appraise for at least $1 million so your portion of the business is valued at $700,000. If the business does not value out, then you may be required to bring additional equity to the table, reduce the purchase price, have the seller carry back the difference in a seller note on full standby, or do a combination of these items.
12) Effective 8/1/23, the SBA has tightened up the Tax Transcript Verification requirements even further. If tax transcripts cannot be received to reconcile with the applicant’s information, the loan must be cancelled, or the closing must be postponed until the issue is resolved. If lenders do not receive a response from the IRS or a tax transcript within 10 business days, the SBA lender may proceed to close the deal but if the information cannot be reconciled at a later date, then the lender might have an invalid guarantee. There are exceptions for when a division of a company is being purchased versus a whole company. Because of this change most lenders have informed me they will not close any SBA 7A loans in the future without receipt of the tax transcripts.
13) Effective 8/1/23, the Personal Resource Test is changing. Under the old test if any Guarantor had substantial liquidity (usually more than the loan amount), the loan would not pass the test and would be ineligible for SBA financing. That test is going away and lenders now have the ability to do a standard “Credit Elsewhere” test where they determine if the loan would readily qualify for standard commercial loans, which is a test required on all SBA 7A loans to begin with. If the loans does not qualify for “Credit Elsewhere”, then they can still make the loan regardless of the liquidity of any one guarantor. Lenders have informed me they will adopt the “Credit Elsewhere” test but that they will still be cautious when there are Guarantors with substantial liquidity to be sure they do not have other conventional financing options available for the loan.
I hope you find this information of help. If any additional changes are made or if I find out that any interpretations contained in this post that are incorrect, I will get updates out. If you have additional questions or would like to discuss any commercial business or real estate financing needs, including business acquisitions via conventional or SBA financing, please do not hesitate to email me at --@----.com or call me at###-###-#### .