As an SBA lender service provider, we see many things during our SBA loan reviews and SBA loan liquidation work.
One area where we often see issues is in Changes of Ownership. They get complicated! The key is to slow down and watch for the details.
Common red flags we see:
An asset purchase that isn’t actually an asset purchase. Sometimes a Borrower will come to you with a real estate purchase agreement for a commercial property they want to buy for their business. The agreement states that FF&E is included. Red flag alert! If FF&E is included, that may mean they’re buying an existing business, not just the real estate. Time to ask questions and clarify. SBA is clear that an asset purchase will be deemed a change of ownership, and must therefore comply with all requirements for a change of ownership, if the Applicant is purchasing all or substantially all of the assets of the Seller’s business and is continuing to operate that business.
The purchase agreement contains language that the Seller will remain with the company to assist with the transition, but provides no further information. Red flag alert! SBA has strict requirements when the Seller remains; you need to ask more questions. There are stringent eligibility requirements for changes of ownership and the Seller’s ability to remain with the company. Simply put, the Seller may not remain as an officer, director, stockholder, or employee of the business. For transitional assistance, the Applicant may contract with the Seller for a period not to exceed 12 months, including extensions. When this is part of a purchase agreement, we recommend that you as the Lender should ask for a copy of the contract with the Seller for the terms of the transition and compensation. (For more on this, see page 97 of the SOP 50 10 7.1 for two exceptions to the rule.)
Purchase Price, Loan Amount, and Business Valuation discrepancies – another red flag alert! SBA limits the loan amount to the value of the business as reflected on the Business Valuation. When the Business Valuation is less than the purchase price, the Borrower must either increase their injection or borrow additional funds from another source. Those borrowed funds must be subordinate to the SBA loan for the full term of the loan. Additionally, during the underwriting process the Lender should consider and discuss why the business would still be worth the price in excess of the valuation, and think through the impact of additional injection on funds available for working capital.
Earnouts and Rebates may raise yet more red flags. The devil truly is in the details. Read the purchase agreements carefully; this is essential to keeping a guarantee. SBA does not allow Seller earnouts. However, rebates based on business performance are allowed.
Finally, look for IRS verifications for the Seller; if these are missing, it’s a serious red flag alert. This is a must in the SOPs, and is viewed as an eligibility issue. Failure to comply is likely to result in a denial of the guarantee, not a repair.
As the Navy SEALs say: slow is smooth, and smooth is fast.
The impulse to rush through any SBA process often leads to delays, repairs, and denials of guarantee. As a SBA Lender Service Provider, we sometimes have to give clients bad news – and believe us when we say, that makes us very sad.
If you’d like to avoid bad news (whether from us or from SBA!), give us a call. We offer SBA loan processor training as well as SBA loan reviews and SBA loan liquidation support. Curious about how we can help? Give us a call at 877-576-0819, or drop us a note through our Contact form. We’re here to help!
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