Here’s an interesting case. What else is new? Almost everything that comes across my email is interesting. I got a call the other day from Jack. He’s a new loan officer with a new client. Jack’s first deal was a hotel with 14 affiliates. We worked through that and hoped his next deal would be easier. But then, it’s SBA lending.
Jack: Richard, here’s my next deal. Grandpa Holler wants to retire. He’s selling his recycling business and its real estate to his grandson Buddy Holler. Grandpa owns the real estate and the business personally. He wants to sell Buddy all the stock in the business. It’ll all be just one 504 loan so as to have the 25-year amortization for debt service. Sounds like an easy project, right?
Me: It’s nice to keep the business in the Holler family. But that doesn’t make it any easier for us lenders. The purchase agreement is the first thing I need to see.
Jack: Well since Grandpa Holler owns the stock and the real estate, and since Buddy Holler is buying both, there’s just this one agreement.
Me: Close family business transactions. You gotta love ‘em! What could possibly go wrong? Jack, I’m sorry to burst your bubble. Tell the Hollers you’ll need two contracts, one a real estate contract that meets your state’s requirements for commercial real estate transactions. The other must be a buy-sell agreement for the purchase of the stock. And that’s just the beginning.
The stock sale isn’t 504 eligible unless the only assets in the business being purchased (e.g., the “target business”) are 504 eligible assets.[i] Since the land and the building belong to Grandpa personally, we need to make sure that the target business has or will have zero other assets and that the equipment is 504 eligible. Since you’ll need to get an appraisal of the equipment anyway — it’s not new equipment, and the seller isn’t arm’s length – might as well get a useful life certification from the appraiser.
Finally, the business must divest itself of cash, receivables, and everything that isn’t a long-term asset. What’s more, the value of the stock cannot exceed the value of the assets being purchased. So Grandpa and Buddy Holler need to get an appraisal of the 504 eligible assets left in the business. And since it’s a close family transaction, you must submit the appraisals with the application.
Jack: Yipes! I gotta talk them into all that?
Me: Yes, but it’s not going to be that hard. Typically, the seller gets the cash that is left in the business and collects the receivables. Then he needs to transfer anything else into his name and get it out of the business.
Jack: Hey! Wait a minute!! I took your Affiliation course, and a grandson doesn’t meet SBA’s definition of a close family member! [ii]
Me: Jack, proud as I am of you, I need to tell you that the regulation for affiliation isn’t the same as the requirements for appraisals in less than arm’s-length transactions. [iii]
Jack: And does the appraisal have to cover 95% of the cost of the stock, just like real estate appraisals?
Me: The 95% requirement has to do with commercial real estate, not stock purchases.[iv] But the SOP says that the difference must be de minimis. So using the real estate standard to determine what is de minimis seems prudent.
Jack: Gee, after that hotel deal, I wanted to get something nice simple. Guess I still gotta find it.
Me: Hey Jack! This is SBA lending!!
Senior Associate, CDC/504 Programs