David W. Starfield, Esq.

                The SBA and lenders frequently require the borrower to prove that it has injected monies into the business in order to assure the borrower's commitment to the project and to reduce the need for additional debt.  With the elimination of the 90% rule for PLP processing, the lender must now determine if the equity and pro-forma debt-to-worth are acceptable based on factors related to the business type, management experience and local competition.  The lender must include a detailed discussion of the required equity in its credit write-up.

                Generally speaking, equity injection is the borrower's money.  But not always.  The big change in the equity arena concerns standby debt.  Debt which is on full standby may often be considered acceptable equity for SBA's purposes.  However, a debt that is on "partial" standby, with interest only payments being made, may be only be considered equity when adequate historical business cash flow exists.  There is one additional wrinkle to the SBA's standby injection rules.  When an SBA guaranteed loan is used to finance a change of ownership that includes intangible assets, if the value of the intangibles exceeds $500,000.00, the borrower and/or seller must provide an equity injection of at least 25% of the purchase price of the business for the application to be processed under delegated authority.  In this situation, seller take-back financing must be on full standby for a minimum of two years.  After that period, the SBA imposes no further SBA injection requirements.

                A common question which often arises is how to interpret the 25% equity requirement when intangibles exceed $500,000.00 and real estate is also part of the SBA financing.  The Agency interprets the rule to mean that the borrower (and seller, if applicable) must inject 25% of the business' purchase price, including intangible and tangible assets.  So, if the intangibles are valued at $600,000.00 and real estate is valued at $400,000.00, a $250,000.00 equity requirement would be needed, not a $150,000.00 contribution. 

                Lenders must verify the injection, including any qualifying standby debt, prior to disbursing loan proceeds and must maintain evidence of such verification in their loan files.  When the amount of injection is $200,000.00 or one-third of the loan amount, the lender must prove both evidence of the injection as well as its source.  This documentation is particularly critical when there is an early default for, without such documentation, the lender risks the loan guarantee and will be faced with a recommendation for a repair or denial.