I got this question just this morning. It’s a knotty one! Let’s untangle the issues and see what kind of solution we can reach.
Q: Hi, Richard. Here’s my question of the day. I got a call from a prospect who wants to refinance $7 million of debthe incurred when he bought his building. But there are a couple of shareholders who each own 10% of the business. They also have liens on the building, won’t subordinate to new financing, and are unwilling to sell their ownership interests and go away. They just want to get paid. Is there any way I can do this loan?
A:The prospect sounded hopeless. Using SBA funds to pay off a shareholder loan might seem an ineligible use of funds. But hold on! Nothing prohibits using funds to pay off a shareholder loan, even if the shareholder will remain an owner – as long as the shareholder is not an”associate.”
And we all know that SBA funds cannot be used to benefit an associate.
We’ve talked about the definition of “associate” before, but it’s time for a recap. SBA defines an associate as one who owns 20% or more of a business, or is an officer, director or key employee of the business, or is an individual or entity controlled by the business.
A minority shareholder isn’t an associate if they don’t own 20% or more of the business or meet the other definitions of an associate. So if the loans the minority shareholders made were used to acquire the business’ building or for other eligible purposes, and the loans are more than two years old, have been secured by the eligible assets for more than two years, and have been current for the last 12 months, they are Qualified Debts, and can be refinanced.
If they don’t meet these criteria,don’t even think about refinancing them as part of “eligible business expenses.” As stated in SOP 50 10 5 (J)“Debt is not included as an Eligible Business Expense” and that includes shareholder or any other kind of debt except perhaps business credit card debt …” (Subpart C, Chapter 2, 3. Eligibility and Other Requirements, g)Eligible Expenses, pg. 301)
Even then, the deal might not bedead if there are Eligible Business Expenses that can be paid off, which would free operating cash to pay off the minority shareholders. Phew!
There’s a new SOP coming in the new year.If anything changes in this regard, I’ll let you know ASAP. In the meantime, I love addressing your questions, especially the knotty ones. Keep ’em coming.
Here’s to a Happy New Year and successful CDC/504 programs in 2019!
Associate, CDC/504 Programs