Have you ever found yourself staring at the SOP knowing what it says, but wondering what it means? I know our clients have been there. After all, they send me questions. And lately, my in-box is full of questions about the required equity injection.
Hold on! Before we begin: Have you noticed that the SOP uses “equity injection” when discussing the 7(a) program, but “borrower contribution” when referring to the 504 program? An attorney I work with in closing SBA loans is always very quick to quiz me to ensure that I’m using the terms correctly. I’ve been known to use them interchangeably. Based on questions clients ask me, I’m sure you’ve done it too.
Now that we’ve got that straight, let’s tackle equity injection. There are three occasions for which SBA requires a certain amount of equity injection:
Occasion #1: Start-Up Business. Now, the SOP becomes a veritable Funk and Wagnall’s Dictionary. A lot of words here need defining: For the purposes of determining the required equity injection, SBA defines a Start-Up Business as one that “… has been in operation (i.e., generating revenue from intended operations) for less than a year.” (SOP 50 10 6, Part 2, Chapter 1, ii. Equity Injection pg. 250; Appendix 3: pg. 536).
So what does “in operation” mean? Operations do not commence with the date the business is formed or when it files an operating agreement with the State, or its “born on date.” Operations commence with the date the business started generating revenue.
Now that we’ve defined “start-up,” the SOP then requires an equity injection a/k/a Applicant contribution (not “borrower contribution”) of a minimum 10% of total project costs. More definitions: Total project costs are defined as “all costs required to become operational,” adding that total project costs are those necessary for a Start-Up Business to operate on a sound financial basis.
But that definition applies only to a start-up. Where to go from here?
Occasion #2. Financing a Complete Change of Ownership. If the financing will result in a new owner owning 100% of the business, then an equity injection of at least 10% of the total project costs is required. Here, total project costs are defined as “all costs required to complete the change of ownership.” Next up:
Occasion #3. Buyout of an Existing Partner. Here, there is no minimum equity injection required but the business’ balance sheets for the previous fiscal year-end and that the current quarter, “… must reflect a debt-to-worth ratio of no greater than 9:1 prior to the change in ownership.” If that cannot be demonstrated, the purchase and sale agreement must show that the remaining owner will contribute cash of at least 10% of the purchase price of the business.
We can close our dictionaries for the day. There are no more equity injection terms to be defined. Class dismissed! Unless of course, you have more questions. I’m here.