What’s that they say, “The only thing constant is change?” PPP, Flood of SBA Notices. Revisions. Program Changes. New Guidance. It’s a wonder we can keep plugging away at everyday SBA lending. We can do it because some things haven’t changed: the fundamentals of our business.
Equity Injection. The rules haven’t changed. Yes, until the end of SBA’s fiscal year, 9/30/21, there are no guaranty or servicing fees. Yet we must remember that Equity Injection rules are the same. Did you know … In some cases, equity injection is a reason for denial or repair to the guaranty of an SBA loan – and that issue is magnified with SBA if a loan defaults within the first 18 months?
A refresher course is in order. Hiding in plain sight: SOP 50 10 6* A quick snapshot:
Start-Up Businesses. Few and far between, but things do change. An equity injection (Applicant contribution) must be at least 10% of the total project costs … (regardless of the source of funds) … for a Start-Up Business to operate on a sound footing.
Change of Ownership. In a business acquisition, the equity injection must be at least 10% of the total project costs. As much as half of that could be a seller note on full standby for the life of the loan.
Sourcing Equity Injection. SBA requires you to source equity injection on all SBA loans regardless of size. Source the equity and its adequacy in your credit memo along with the conditions for collecting the appropriate supporting documents. Injection sources can be:
- Cash not borrowed
- Cash borrowed through personal loan to the business owner
- Assets other than cash
- Standby Debt
- Gifted Funds
- equity injection cannot come from the borrower yet it could in some cases where the money is borrowed. The challenge: How to prove that a loan is being paid outside the business cash flow. Approach with caution! What’s in the SOP?
“Cash that is borrowed through a personal loan to the business owner with repayment demonstrated to come from a source other than the cash flow of the business (the salary paid to the owner by the business does not qualify). If the personal loan is made by the participating Lender, the Lender must submit the application through non-delegated 7(a) processing. “
Document. Document. Document! As always, the proof is in the supporting documentation:
- Cash not borrowed: Provide at least two months of consecutive statements reflecting the funds available. Some lenders require a business account be set up to hold funds for two-three months so proof of injection is at their fingertips.
- Cash borrowed through a personal loan to the business owner: Provide a Copy of Note and an analysis:
- demonstrating that repayment will come from a source other than the business, e.g., spouse, salary income;
- distributions from affiliates should be reflected in the affiliate’s financials, meeting minutes or a corporate resolution. Affiliate loans require a copy of the Note and full standby for the term of the SBA loan.
- Assets other than cash: For example, equipment purchased previously and/or supported by a 3rd party appraisal if the applicant claims value greater than the depreciated value;
- Standby Debt: Shareholder debt placed on full standby for the term of the loan.
- Gifted Funds: Two months of account statements from the Giftor, Gift Letter, and wire/cancelled check to show that funds were received from Giftor
Foe multiple sources of injection, a spreadsheet will help you demonstrate that injections have been made and properly documented. The required form, SBA Form 1050 will help your documentation, including equity injection.
Yes, the fundamentals haven’t changed: sound underwriting, prudent lending practices, comprehensive policies and procedures. And the fundamental of all fundamentals: Documentation. In short, following the rules and regs will help local businesses, build your loan portfolios, and protect your guaranty.
*See SOP 50 10 6 Part 2, Chapter 1, pgs. 252 & 255; Part 2 Chapter 5, D. pg. 442 for full details