Change of ownership can be sticky. Especially when one party uses a 7(a) loan to buy out the other party. Larry, a loan officer I’ve known for ages, called me with this story:

Moe & Curly owned Moe & Curly’s Auto Repair equally. Suddenly, Moe retired. Curly got a 7(a) loan and bought out Moe’s interest with the proceeds. Larry was the loan officer who handled the transaction. It’s his custom to do business with his bank’s customers. So when his car started to shake and rattle, he rolled into Moe & Curly’s. Larry went to check on his car and got a big surprise: Whose head popped up from under the hood? Yep. It was Moe!

Larry thought Moe was long gone, retired to the Rocky Mountains. How things can change. It’s tough to split up a successful team. When the customers found out Moe was leaving, they threatened to take their business to Dean & Jerry’s Repair Service. So Curly asked him to stay on to help retain customers.

LARRY. Richard, I feel so uneasy. I’m stuck and feel a little like a stooge. What am I supposed to do? I cannot in good conscience just forget that I saw Moe working there. I realize SBA allows the seller to stay on for up to 12 months, But nowhere in the Purchase Agreement was it disclosed that Moe would stay on for any period. Can you help?

ME. Wow, Larry. You should feel uneasy. Using a 7(a) loan for Change of Ownership can have underlying issues. Here’s some important FYI:

SBA has had two time-honored principles since its inception: 1) that owners aren’t supposed to put loan proceeds in their pockets, and 2) that loan proceeds aren’t to be used by individuals to invest. Both are violated by changes of ownership.

Yet a change of ownership can be used by the business to preserve its existence and contribute to its future success. So SBA allows for financing a change in ownership, but only as a policy exception. And importantly, to qualify for the policy exception, there must be a complete fracture: The seller must truly depart. Adios, So Long. Bye-Bye. Farewell. No proceeds may be used to allow a seller to retain a partial ownership share or to purchase a portion of another owner’s interest.

That’s how changes of ownership are reconciled with those two long-standing principles. It’s been the Agency’s policy since Caesar crossed the Rubicon.

Larry, you have an obligation to inquire into the details of the sale and to disclose this to SBA. It can be possible for a seller to remain on as an employee, so long as the seller isn’t a “key” employee. Check out the definition of a “key employee” of a borrower on page 531 of SOP 50 10 6:  “Any person hired by the business to manage day-to-day operations.”

Important Takeaway. I’m in no position to say whether Moe is a key employee. But remember that the seller’s ability to remain at all involved in the business is an SBA policy exception. Moe was retained for client retention purposes, not to operate the copy machine or to be in a clerical position. So any assertion that Moe isn’t a key employee shouldn’t be accepted lightly.

While it might be too late for Larry on this loan, he and I agreed that in the future, loans for change of ownership would be scrutinized to ensure that the Purchase Agreement includes a full fracture of the seller and the targeted business.

Richard Jeffrey
Senior Associate
Head Underwriter
richard@jrbrunoassoc.com
www.jrbrunoassoc.com