welcome
For Today’s Session
• Quick review of recent legislative changes
• Update regarding coming changes to program
requirements
• Discussion of some of the most difficult issues facing
lenders now
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The SOP 50 10 Fix
Wisconsin Lenders Conference ~ May 19, 2016
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Veterans Entrepreneurship Act of 2015
(7/28/2015)
• Changes:
• Increased 2015 7(a) program level from $18.75 to $23.5
billion putting 7(a) back in business after the entire
2015 authority had been used up by 7/22/2015
• Made the fee waiver for SBA Express loans to veterans
permanent as long as no appropriations required for
7(a) loans (zero subsidy)
• Clarified credit elsewhere test requirements (change
effective 10/1/2015 – more on this later)
• Added new requirements for SBA to report various
data to the Congress
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Consolidated Appropriations Act of 2016
(12/18/2015)
• Provided a 7(a) program level for FY 2016 of $26.5
billion (zero subsidy)
• Provided a 504 program level for FY 2016 of $7.5 billion
(returned to zero subsidy)
• Provided debt refinancing authority for the 504
program with defined parameters effective when the
program is at zero subsidy
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Pending Changes to
Program Requirements
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Pending New Regulations
• Final Rule on affiliation/franchises
• Will reflect public comments received in response to 3
requests for comments on affiliation and franchise
requirements and processes
• “Catch-all” regulation –
• Non-substantive housekeeping changes, e.g., removal of
references to CLP, some modifications to oversight
requirements and (hopefully!) minor change to clarify
EPC/OC requirements
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Two New Versions of SOP 50 10 Pending
• SOP 50 10 5(I) –
• Expected to be issued soon
• SOP 50 10 6 –
• Expected to be issued by the end of the year
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SOP 50 10 5(I)
• Expected to include –
• Changes from upcoming regulations regarding
affiliation/franchises eligibility and process AND
• Additional guidance regarding meeting credit
elsewhere requirements
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SOP 50 10 6
• Rumor (subject to change!) has it that among possible
changes in the SOP are –
• Re-ordering of material – possibly to discuss by
program (e.g., CAPLines) as opposed by topic (e.g.,
collateral)
• EPC/OC – to track to pending regulation changes
• 912 process – possibly making fingerprinting
mandatory which will speed up process
• Equity requirements/100% financing – requirements for
lenders’ discussion regarding leverage
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Difficult Processing Issues
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Issues Under Greatest Scrutiny
• Credit Elsewhere – appropriately documenting that
statutory test is met
• 100% Financing – determining whether and how
much equity injection to require
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Credit Elsewhere
• Threshold issue – loan is NOT eligible if credit elsewhere
test is not met
• Congress, GAO, OIG and SBA, especially OCRM, are
looking to assure that lenders are not using the SBA
guaranty to make a loan that could be made conventionally
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“Credit Elsewhere” Defined
Small Business Act, Section 3(h):
• For purposes of this Act, the term “credit elsewhere”
means the availability of credit from non-Federal
sources on reasonable terms and conditions taking into
consideration the prevailing rates and terms in the
community in or near where the concern transacts
business, or the homeowner resides, for similar
purposes and periods of time
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Credit Elsewhere Requirements
• No financial assistance shall be extended pursuant to
this subsection if the applicant can obtain credit
elsewhere [Small Business Act, Sec. 7(a)(1)(A)]
• “The Small Business Applicant Must Demonstrate a
Need for a Guaranty on the Loan” [5(H), page 87]
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Documenting “Need for Guaranty”
• Lender must document in the loan file the “factors that
prevent the financing from being accomplished without
SBA support”
• This is not a box-checking exercise
• Rationale must be specific to the individual loan – a
generic statement is NOT enough
• Credit elsewhere issue is on Congress’ radar screen as
evidenced by 7/2015 legislation – expect greater
scrutiny of how SBA and lenders satisfy the statutory
mandate!
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Factors That Demonstrate ‘Need’
i.e., “Credit Elsewhere Test”
Acceptable factors:
• Need for longer maturity than lender policy permits
• Loan exceeds lender’s legal lending limit/policy*
• Lender liquidity depends on secondary market*
• Inadequate collateral under lender policy
• Violates lender policy regarding loans to new
businesses or in applicant’s industry and/or
• Any other factor related to credit that require guaranty
* Per recent statute neither can be sole justification
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Meeting Credit Elsewhere Test (cont)
Unacceptable factors:
• To address CRA compliance
• To refinance debt already on reasonable terms
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What you should be doing now . . .
• Watch for clarifying guidance from SBA expected out
soon
• In the meantime –
• Follow current guidance and
• Write your credit elsewhere justifications so that they are
fact-specific to the individual loan
• This is NOT a box-checking exercise and
• A standard blurb is NOT enough
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Equity Injection Requirements
Loans of $350,000 and less –
• Lender must determine if equity and pro forma debt-toworth are acceptable based on its policies on similarly
sized non-SBA loans
• If equity injection required, must be verified if lender’s
policy would require verification on conventional loans
...
5(H), page 159
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Equity Injection Requirements (cont)
Loans over $350,000 –
• Adequate equity important to long-term survival of business
– SBA generally EXPECTS equity injections!
• Lenders who do not require an equity injection, particularly for
R/E purchase, business start-up, or change of ownership loans
may be putting their guaranties at risk
• Lender must determine if equity and pro forma debt-toworth are adequate
• Credit analysis must include detailed analysis of required
equity and its adequacy
• NAGGL cautions you provide strong rationale if no equity
injection is being required
5(H), pages 163-164
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What you should be doing now . . .
• Watch for clarifying guidance from SBA
• In the meantime, remember –
• 100% financing may be appropriate in an individual loan
situation BUT
• Consideration/justification of equity injection especially
important when loan is to start a new business, accomplish
a change of ownership, or purchase real estate
• Lender must document rationale for not requiring an equity
injection AND
• SBA has signaled that they are scrutinizing situations
where lender is making all or most loans without requiring
an injection
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What are Acceptable Equity Injections?
Issues:
• How far back in time can a lender go when considering
an applicant’s prior purchases as equity?
• What kind of expenditures counts – e.g., franchise fee,
travel in connection with mandatory franchise training,
purchase of equipment, payment of fees, payment for
services, etc.?
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Acceptable Equity Injections (cont)
Answers: Per SBA – not in SOP
• Payment must appear to reasonably have been made
as part of current project
• No specified limit on how far back in time, BUT a
reasonableness test should apply
• Pro forma statements should recognize expenditures
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Calculating Equity in Partner Buy-Out
Scenario: change of ownership between existing owners,
more than $500,000 in intangibles, lender wants to
process via PLP
• Issue: How does lender show mandatory 25% equity
injection requirement (buyer/seller combo) is met for
PLP processing
• A: Per SBA – not in SOP:
• Equity determination based on equity shown on posttransaction pro forma balance sheet (for this purpose only
– not in compliance with GAAP)
• That figure will reflect adjustment to equity based on
creation of new debt obligation
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EPC/OC Loan Structures
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EPC/OC
• Per regulations and SOP (pages 104-107), EPC must use
loan proceeds to acquire or lease, and/or improve or
renovate real or personal property (including eligible
refinancing) that it leases to an active OC business
• Trickiest issue is when there is a holding company
structure and 7(a) financing is being requested for a
change of ownership – generally . . .
• Complete changes of ownership involving holding
companies are eligible BUT
• Partner buy-out situations involving purchase of holding
companies are not eligible
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Why do Small Businesses Choose
Holding Company Structures?
• Why do small businesses use holding companies to
own R/E, or major equipment?
• Avoid potential liability – e.g., medical practice
seeking to safeguard its building or major equipment
from malpractice suits
• Tax implications
• Estate planning
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Why does SBA have Special
Requirements for Holding Companies?
• Holding company structure interjects an extra layer in
the loan structure, BUT –
• Benefits of loan still accrue to operating company
• Major concern is that loan proceeds not be used for
passive investment purposes
• SBA requirements assure that holder of asset does not
benefit from SBA loan – no return on investment until
after 7(a) loan is repaid
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Who is the Borrower?
• EPC = primary borrower [may take any form of business
structure, including tenants-in-common]
• Owns the asset
• Receives the financing for the asset
• Only one EPC per loan is allowed
• OC = either a co-borrower or a guarantor
• OC must be co-borrower if it receives any loan
proceeds for its use (e.g., w/c, asset purchase, stock
purchase, intangible assets, etc.)
• Multiple OCs are allowed
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EPC Eligibility Requirements
• EPC and OC must each be small
• Proposed use of proceeds must be eligible as if OC
were obtaining financing directly
• OC must be co-borrower OR give unlimited guaranty
• All 20% or more owners of EPC and OC also must
personally guarantee
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Other EPC/OC Requirements
• Lease restrictions assure that it is the OC, not the EPC, that
controls the real or personal property
• EPC must lease project property directly to OC under a
written lease with term (including options) at least equal to
loan term
• Lease payments must be assigned to debt
• Rent cannot exceed:
• Debt service + property upkeep + taxes + insurance
• OC(s) must lease 100% of property but can sublease
consistent with space occupancy requirements
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EPC Scenario 1
• Existing medical practice currently operating out of
leased space wants to use a holding company to
purchase the building from which it is operating
• Proposed EPC/OC loan structure with newly formed entity
holding real estate
• Holding company (EPC) will be borrower; medical practice
(OC) will give unlimited guaranty
• Eligible for 7(a) financing?
• Eligible for 7(a) financing if, instead of R/E, medical
practice wanted to buy an MRI machine?
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EPC Scenario 1 – Analysis
• Loan is eligible as proposed for either R/E or MRI
machine, subject to the following –
• EPC will be borrower
• OC may be either co-borrower or guarantor
• All 20% or more owners of each must fully guaranty
the loan AND
• All other EPC/OC loan conditions must be met –
• e.g., assignment of lease proceeds, amount of
lease payments, term of lease, space occupancy
requirements, etc.
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EPC Scenario 2
• Loan for complete change of ownership – business
assets currently owned by an operating business, R/E
currently owned by holding company
• Dad will be 100% owner of R/E and have 10% ownership
interest in operating business
• LLC owned by son and daughter-in-law will own 90% of
operating business and will operate the business
• Proposed EPC/OC loan structure –
• One loan with EPC (dad) and OC (LLC) as co-borrowers,
proceeds for purchase of R/E and other assets
• Eligible for 7(a) financing? Can transaction be financed
with one loan?
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EPC Scenario 2 – Analysis
• Loan is eligible as proposed –
• Financing may be made via one loan with dad (as
EPC) and LLC as co-borrowers
• All other eligibility criteria must be met
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EPC Scenario 3
• Applicant, an operating small business, wants to buy
the stock of a real estate holding company that holds,
as its only asset, a parcel of R/E which applicant will
use for its business
• Applicant wants to continue to hold R/E in a holding
company
• Eligible for 7(a) financing?
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EPC Scenario 3 – Analysis
• Loan is NOT eligible as proposed –
• SBA does not permit using a 7(a) loan to purchase a
passive business, in this case the holding company
BUT –
• SBA would provide financing for the applicant to
purchase the R/E from the existing holding company
in an EPC/OC structure subject to all of the EPC/OC
requirements
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EPC Scenario 4
• Loan requested for –
• Partner buy-out involving both an operating company
and a company that holds the real estate out of which
the business operates (identical ownership structure
for both – 50/50)
• Proposed as one loan with an EPC/OC structure
• Eligible for 7(a) financing as proposed?
• Eligible for 7(a) financing if the remaining owner
purchases the R/E from the holding company?
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EPC Scenario 4 – Analysis
• Loan is NOT eligible as proposed –
• SBA prohibits an associate of the applicant business
from receiving the proceeds of a 7(a) loan, and as
noted in scenario 3, SBA also prohibits the purchase
of a holding company
• So, while the purchase of the OC would be eligible,
the purchase of the holding company, or of the R/E
held by the holding company, would not be
Note: it has been suggested that one solution would be to have
the holding company quit claim the deed to the OC – SBA does
not condone this strategy because of tax implications and
issues of lender liability
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Other Tough Issues
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Debt Refinancing
[Covered in much more detail in separate session]
Scenario: Applicant wants to refinance a seller take-back
note created 25 months ago when applicant purchased
business – note was on full standby for the 1st 24 months
Q: Is the loan eligible for refinancing?
A: No. SBA recently clarified that in order to refinance a
seller take-back note on a change of ownership, not only
must the note have been in place for two years, but it
must have been receiving payments for that time in order
to meet the requirement that it have been current for the
two year period.
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Reimbursements to Applicant
from 7(a) Proceeds
• Issue: regulations and SOP prohibit 7(a) proceeds being
used for payments, distributions or loans to an
“associate” of business (except for ordinary
compensation for services rendered) [13 CFR 120.130(a)]
• So, historically SBA has said that funds advanced by the
business (including a sole proprietor) can be reimbursed
from loan proceeds, but funds advanced by a business
owner cannot be reimbursed
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Reimbursing Applicant from 7(a) Loan Proceeds
Scenario: After 7(a) loan approved, applicant found a great
deal on equipment that was to have been purchased with
loan proceeds – now wants to be reimbursed for purchase
from loan proceeds
• Q: Is such reimbursement allowed?
• A: It depends. Under current interpretation, loan
proceeds could be used to reimburse applicant
business, but not business owner – funds expended by
owner could be considered to be part of equity injection.
• Best practice: Encourage applicant to establish a
business checking account immediately and to use that
account to pay all business expenses
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Wisconsin Lenders Conference ~ May 19, 2016
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Proving Repayment Ability
When Relying on Projections
• Issue: how soon does a new start business have to meet
SBA’s mandatory debt service coverage ratio (1.15:1)?
• Scenario: new start membership business (gym)
• General discussion contemplates 12 months, but a longer
period (18-24 months) can be used if circumstances warrant
• Lender must provide –
• Rationale for allowing longer ramp-up period AND
• Month-by-month projections for entire period showing
adequate W/C to assure business survival until break-even
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The SOP 50 10 Fix
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Collateral – Trading Assets
• Issue: whether/when SBA requires lien on trading assets
(inventory/accounts receivable)
• SOP says lender “may” take such assets (page 166)
• When depends on the purpose of the loan and whether
the trading assets need to remain available to secure
needed LOC financing
• If loan purpose is W/C, inventory, etc., lien should be
taken; otherwise not mandatory
• Lenders have advised LGPC sometimes requiring lien
even when not mandatory – lender may need to appeal
decision on a case-by-case basis
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Loans to Purchase Raw Land
• Issue: whether 7(a) loan can be used to purchase raw land
• Facts: applicant seeking to buy land with anticipation that
it will construct a building to house its business sometime
in next 6 months to 2 years – eligible?
• Not specifically addressed in SOP, but SBA’s informal
advice is “probably NOT eligible”
• Rationale –
• Purchasing raw land is inherently speculative
• Uncertainty regarding financing for construction
• Uncertainty that building will ever be built or, if built will meet
SBA’s space occupancy requirements
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Maximum Loan Term
• Regulations and SOP (page 132) mandate that loan term be
shortest appropriate term considering –
• Use of loan proceeds – SOP specifies MAXIMUM terms
available, NOT automatic maturity
• Borrower’s ability to repay
• Issue: LGPC has been setting maturities for shorter periods
than lenders believe appropriate
• Cited rationale is that lenders can later extend (up to 10 years
longer if necessary)
• Longer terms help to assure repayment ability if times get
tough – BUT balancing act required
• Cash flow projections must support term requested/given
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The SOP 50 10 Fix
Wisconsin Lenders Conference ~ May 19, 2016
47
Flood Insurance
• Issue: Can lenders allow a borrower to purchase private
flood insurance when a property is located in an NFIP
community and NFIP flood insurance is available, but
more expensive?
• A: Per SBA, yes!
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LSPs, Fees, SBA Form 159
• Issue: How do you report fees > $2,500?
• A: SBA has confirmed that even when fees are calculated
as a percentage of loan, they must be itemized – i.e., a
list of the work performed must be provided
• Issue: Can lender pass on to borrower, the fees that it
pays to LSPs for handling routine disbursement and
servicing actions, e.g., disbursing funds or processing
(for lender review and approval) a request for a
deferment, release or exchange of collateral, etc.?
• A: NO – listed functions are considered to be
administrative responsibility of lender
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LSPs, Fees, SBA Form 159 (cont)
• Issue: Does submission of loan (including Form 159)
via SBA ONE constitute providing copy of form to SBA?
• A: Yes
• Issue: Does the $30,000 fee limitation (when fees
charged as a percentage of the loan) apply only to fees
paid by borrower, or to fees paid by lender as well?
• A: SBA has confirmed that the $30,000 fee limitation
applies only to fees paid by borrowers
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Questions?
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Not Yet a NAGGL Member?
• NAGGL is THE VOICE of the 7(a) industry with the SBA, the
Administration and the Congress
• NAGGL offers its members a full range of services including
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The SOP 50 10 Fix
Wisconsin Lenders Conference ~ May 19, 2016
52
Copyright © 2016, NAGGL, Inc. All rights reserved. Nothing may be reprinted in whole or part without written permission from NAGGL.
The SOP 50 10 Fix
Wisconsin Lenders Conference ~ May 19, 2016
Copyright © 2016, NAGGL, Inc. - Do Not Copy/Distribute
18