SOP 50 10 5(C) previously provided that "[a]n 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 one or more Operating Companies (OC) for conducting the OC's business." SOP 50 10 5(D) adds to this language the following prohibition: "An EPC may not use loan proceeds to acquire a business, acquire stock in a business or any intangible assets of a business or to refinance debt that was incurred for those purposes." SOP 50 10 5(D), pages 124-125. SBA has indicated that this change is intended to restrict the use of proceeds in an EPC/OC transaction to those uses that are eligible for an EPC, plus working capital and the acquisition of fixed assets by the OC. This interpretation raises a dilemma for lenders: how should a change of ownership be processed if the Borrower wants to split out the ownership of the business real estate to an EPC? The new clarification of SBA's position on this issue equates being an "obligor" on the note, with "use" of the loan proceeds, an interpretation that was not widely held by lenders previously. This new policy interpretation will require lenders to split business acquisitions that include EPC owned real estate into two loans, increasing costs to both the borrower and the lender, with little or no additional protection to the agency. Additionally, Lenders should be mindful that if the value of intangible assets exceeds $500,000, the borrower must inject 25% of the entire project (including business purchase and real estate) to process the loan PLP. Resolution of this issue is uncertain.

            The SBA also changed its policy on debt refinancing. SBA added the limitation that "SBA guaranteed loan proceeds may not be used to refinance debt in the personal name of the owners, with the limited exception ... for credit card debt in the personal name used for business purposes." SOP 50 10 5(D), page 132. Thus, whereas existing debt in the personal name of the business owners, such as a home equity loan whose proceeds were used for business purposes, was previously eligible for refinancing with an SBA loan, such refinancing would now be ineligible. As this appears to be a "straight line" rule without exception for any type of debt other than eligible credit card debt, and lenders must undertake a careful examination not just of the nature of the debt proposed to be refinanced (i.e., whether the proceeds were used for business purposes), but also the names in which the debt was incurred. Additionally, implicit in this new rule is that SBA lenders will be required to prove that debt refinanced in individual names (such as sole proprietor and individual EPC debt) was incurred for business purposes. This may be an impossible standard for lenders to meet in certain circumstances, as documentation of the business purpose of a loan may not be readily available.

            While in SOP 50 10 5(C) the SBA amended the change in ownership provisions to require that the business be the borrower when loan proceeds were to be used for a change of ownership, with the apparent intent that such provision be interpreted to require that stock transfers be structured to require the business to redeem the entity's stock (rather than a direct transfer of stock from a seller to a buyer), the SBA has now added an express provision requiring such a transaction to be structured as a redemption:

"The Small Business Applicant is acquiring 100% of the ownership interest of one or more exiting owners. When a change of ownership is between existing owners, this must be accomplished through redemption of stock by the corporation or through the purchase of a partner's interest by the partnership. A partner, shareholder, or an unrelated third party may not use SBA-guaranteed loan proceeds to purchase an existing owner's interest in the business." (emphasis added)

See SOP 50 10 5(D), page 138. As we have discussed in a previous article, the requirement that a change of ownership be structured as a redemption may have significant tax consequences (such as lack of basis in the shares issued to the new owners, etc.). This policy also removes stock purchase as an option to convey a business, leaving asset purchase as the only eligible option for SBA financing. In addition, this change leaves open the question of whether the redeemed stock/interests may be re-distributed to the owners of the business and if distributed for nominal consideration, what tax implications this will have on the new owners of the stock. Because of the implications this policy has on parties' ability to structure transactions and the potentially adverse tax consequences, this policy will likely be the subject of further discussion, interpretation and refinement.

            These changes represent just a few of the important revisions included in SOP 50 10 5(D). Stay up to date on the latest changes to the SOP and maintain the integrity of your SBA guaranty. For more information regarding these and other changes to the SOP that become effective on October 1, 2011, contact Ethan at esmith@starfieldsmith.com, or 215-542-7070.

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