Wow! Thanks for all your emails answering the puzzler in our last 504 eBulletin, Refi or Purchase? Who’s Right?  You are all experienced 504 lenders. So naturally, you all got it right. As promised: The Great Reveal:

Of Course, It’s Cathy. People seem to have agreed with Cathy’s statement that the project will finance a startup. Interestingly, no one who emailed us argued that the project wouldn’t be financing a new business. As you know, a new business is one that has been operating for two years or less at the time the loan is approved.

Since the property was in foreclosure, it’s likely that the applicant does not meet the requirement to have been “…in operation for all of the two-year period ending on the date the application is submitted, as evidenced by the financial statements submitted at the time of application.” (SOP 50 10 7.1, pg. 294).

Yes, the loan request cannot be a refinance because the business hasn’t been in operation for at least two years. So, that tells you the minimum borrower contribution must be at least 15%.

We do not know the buyer’s plans for the property. Cathy seems to assume that the property will be special purpose, which is a good guess. The property was a hotel and is probably configured as a hotel, so it will take some work to change that “special purpose configuration.” We should ask our borrower of course, but it’s probably safe to assume that he plans to continue to use the property as a hotel or some sort of special purpose property.

So that means another 5% borrower contribution at a minimum. We are now at 20%.

Up for a Challenge? Due to the foreclosure, it would be quite a feat to show that the business had been in operation for all of the two years prior to applying for the loan. Want to try? As long as you have historic tax returns for the two years prior to the application, and provided the hotel has been operating during the foreclosure, and if the buyer had the experience, you might make a credible argument that it is an existing business. Among the remaining challenges at that point would be showing adequate cash flow, which might be neither a piece of cake nor as easy as pie.

So Cathy is right and Edgar gets held back to take Remedial Deal Structuring 101.

Richard Jeffrey, Senior Associate
CDC/504 Program