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SBA Equity Requirements

Posted: 2/15/2018
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SBA loans fund a variety of business needs including business acquisition or owner occupied real estate, fixed-asset purchases such as computers, equipment, vehicles and machinery, business expansion and permanent working capital, start-up business expenses and refinance of existing debt.

Each year, new Standard Operation Procedures (SOPs) are introduced as it relates to SBA lending programs and the lenders who participate. Here, we have broken down SOP 50 10 5J, covering new mandates for SBA 7a and 504 loans.

Regardless of the loan type, the lender must determine if the equity position, any required equity injection and the proforma debt-to-worth are acceptable based on factors related to the type of business, experience of management and the level of competition in the area.

A business in operation up to one year is considered a start-up. New equity requirements for start-up businesses include injection of at least 10% of the total project costs (all costs are required to become operational, regardless of the source of funds).

If a change of ownership results in a new owner:

  1. Injection of at least 10% of the total project costs (all costs are required to complete the change of ownership which includes working capital, closing costs, SBA guaranty fee, etc.)
  2. Seller debt may be considered as part of the equity injection if it is put on standby allowing no payments of principal or interest for the life of the SBA loan.
  3. Seller debt, if used towards the injection, cannot exceed half of the required injection.

If a change of ownership is the result of a partner buyout, then:

  1. The proforma equity position after the change of ownership must be at least equal to 10% of the total assets.
  2. This could potentially be required with no additional injection by the remaining owners, otherwise the remaining owners must provide an additional injection that will result in at least 10% net worth.

Sources of equity injection include cash that is not borrowed, cash that is borrowed through a personal loan to the business owner, project related assets other than cash and standby debt (debt that is on standby allowing no payment of principal or interest for the term of the SBA loan may be considered equity). Any cash that is borrowed through a personal loan to the business owner must demonstrate repayment coming from a source other than the cash flow of business. Salary paid to the owner by the subject business does not qualify. In addition, lenders are required to substantiate the value of project related assets other than cash with an independent third-party valuation.

Sources of equity injection that are not allowed include value or cost of education and funds that are borrowed that do not meet the criteria mentioned above.

Documenting an injection will be required. When doing so, be sure that:

  1. You have a copy of the check or wire transfer along with evidence that the check or wire was processed.
  2. You have a copy of the two most recent bank statements from the account where funds are/were withdrawn, showing that funds were available.
  3. If funds to be used toward the injection were spent prior to close, you retain a copy of the related invoice.
  4. If funds to be used toward the injection were gifted funds, a gift letter showing that those funds are not expected to be paid is required. Additionally, the documentation above is needed for the account of the individual who provided the gift.

Your lender should be in contact if any of these updates apply to you or if they affect your loan in any way.

 

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