Loan proceeds from a SBA 7(a) loan may not be used to purchase a portion of a business or a portion of another owner's interest in a business.  However, SBA 7(a) loan proceeds may be used to purchase business assets or interest that result in a complete change of ownership.  See 13 CFR 120.202.  A complete change of ownership occurs when the Borrower purchases 100% of the ownership interest in the business (either by asset purchase or stock purchase) or an existing owner purchases the stock or membership interest of a selling owner or owners resulting in the purchaser owner owing 100% of the outstanding stock or membership interest.  See SOP 50 10 5(B) Subpart B, Chapter 2, Paragraph IV, Section G. 1.

It is important that an SBA lender properly investigate and document change of ownership. The lender must first look at the target company's books and records to determine the company's current authorized and issued equity interests (either shares or membership interests) and the current holders of those outstanding equity interests.  Next, the lender should review the purchase agreement to determine that the selling equity holders are selling all of their equity interests to either a non-equity holder or to one (1) existing equity holder, who will, upon closing, be the 100% owner of all the outstanding issued equity interests in the company.  Upon closing of a purchase transaction, the lender should obtain (i) copies of the  assignments of the stock or membership certificates from the seller(s) to the borrower, (ii) copies of the cancelled stock or membership certificates of the seller(s) and (iii) copies of the newly issued stock or membership certificates in the name of the borrower.

In an asset or equity purchase transaction, lender should also review the purchase documents to make sure that the seller(s) does not remain an Associate of the borrower.  An "Associate" of a small business is defined as (i) [a]n officer, director, owner of more than 20 percent of the equity, or key employee of the small business; (ii) [a]ny entity in which one or more individuals referred to in [section (i) of ]this definition owns or controls at least 20 percent; and (iii) [a]ny individual or entity in control of or controlled by the small business (except a Small Business Investment Company ("SBIC") licensed by SBA). 13 C.F.R. 120.10.  Therefore, lenders should also obtain copies of the seller's resignations from the board of directors and/or as officers and employees of the company. 

However, the SBA does permit sellers to remain as a consultant to the business for a short transitional period of time after the sale, so long as such agreement is for less than 12 months.  Such arrangements should not be in the form of employment agreements.  A lender should be careful that any such arrangement does not result in the seller retaining control over the borrower or providing another source of payment for the business which is not included in the purchase price.

Since the SBA treats a change of ownership as "new" business, some additional lender documentation requirements include the following:

• IRS verification identified in 50 10 5(B) Subpart B, Chapter 5, Paragraph III.C.
• Business valuation (excluding real estate)
• Site visit of the assets to be acquired
• Real estate appraisal for acquired commercial property, if any
• An analysis as to how the change of ownership will benefit the business (not the seller or the buyer). If the analysis cannot support that the change of ownership will be in the best interests of the business and its continued, successful operations, then the loan request must not be submitted to SBA for its guaranty.

For more information on Change of Ownership or SBA 7(a) loan documentation please contact Kimberly A. Rayer, Esquire at krayer@starfieldsmith.com or 215-542-7070 ext. 144.