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SBA Eligibility 101

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August 15, 2013

SBA Eligibility 101

By Charles H. Green

Bob Coleman recently presented a webinar on SBA loan program eligibility recently. Joining him was Gina Rodgers, Manager of Training and Personnel for Banc-Serv Partners, LLC based in Westfield IN.

The webinar was introduced as an in-depth look at standard 7(a) program eligibility through many of the most common requirements that assist lenders when making an eligibility determination. “Keep in mind that each deal is different – they are all unique and require individual review of both business and principle owner information that’s provided,” said Rodgers.

In addition, there are specific loan requirements and other mitigating factors that relate to the suggested transaction collateral, debt refinancing and environmental circumstances that could add different elements required to be taken into account when reviewing eligibility.

Eligibility Basics

Winnowing down the large number of discriminants that determines 7(a) program eligibility is much like answering a repetitive set of questions, and is probably the easiest method to manage process. The most elementary questions might be:

Is the business owner operated? Is the business organized for profit? Is the business located within the United States (includes territories and possessions)?
Are they within the size guidelines designated by the SBA? And does the borrower demonstrate a need?

Are they unable to secure credit under other reasonable terms? Has the business its owners paid their appropriate taxes and are they current with taxes now? Are principals of the business with 20% or more ownership of good character? Have they met the lender’s credit requirements?

Have all available assets been pledged and personal assets and resources evaluated by lender? Is the proposed ‘use of proceeds’ eligible? Does the maturity and interest rate fall within the allowed SBA guidelines? Has the lender practiced prudent lending in evaluation of this credit?

The next step may be to use the SBA’s 7A SBA Eligibility Questionnaire to further assist in the evaluation of a loan request’s eligibility. “This questionnaire is a wonderful tool, and guides lenders through each point of eligibility that requires review,” explained Rodgers. The questionnaire can be found on SBA’s website at http://www.sba.gov/sites/default/files/7aLGPC_EligibilityQuestionnaireVersion50105_D_20111122_0.pdf.

The questionnaire starts out with a checklist of non-eligible business categories that would stop a lender early in the review process. Business categories not eligible for assistance include businesses that are described as being:

1) a non-profit, 2) primarily engaged in lending, 3) a passive business owned by developers or landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds, 4) a life insurance company, 5) located in a foreign country or owned by undocumented aliens, 6) a company selling through a pyramid or multi-level sales distribution plan, 7) business deriving more than a third of its revenue from legal gambling activities, 8) engaged in any illegal activity, 9) restrictive as to patronage for reason other than capacity, 10) a government-owned entity or 11) a consumer or marketing cooperative.

Other conditions that may deem a borrower to be ineligible for SBA financing assistance include:

1) earning more than 1/3 of its gross annual revenue from packaging SBA loans, 2) having an associate who is incarcerated, on probation, on parole, or has been indicted for a felony or a crime of moral turpitude, 3) is fully or partially owned by the lender or any of its associates, 4) presents live performances of a prurient sexual nature, 5) engaged in teaching, instructing, counseling or indoctrinating religion or religious beliefs, 6) has defaulted on a federally-assisted financing resulting in the federal government sustaining a loss, 7) engaged in political or lobbying activities, or 8) speculative nature of business (such as a shopping center developer, oil wildcatting, or primarily engaged in R&D).

Other Eligibility Requirements

Size Standards – The business must be considered “small” under the SBA’s size standards in order to be eligible for financing assistance. The applicant business alone (without affiliates) must not exceed the size standard for the industry in which the applicant is primarily engaged.

If there are affiliated businesses, the applicant business combined with its affiliates must not exceed the size standard designated for either the primary industry of the applicant alone or the primary industry of the applicant’s affiliates, whichever is higher. Guidance for determining size eligibility can be found in the SOP 50 10 5 E pg. 92.

“Each distinct business category defined by the North American Industry Classification System (NAICS) is assigned an eligibility limitation by SBA, usually expressed as either the maximum annual revenues or the maximum number of employees, to determine if they are officially a ‘small’ business,” Rodgers explained. “These limits can be found in the SBA’s Table of Small Business Size Standards.”

Affiliation – An ‘affiliation’ exists when one individual or entity has the power to control another or a third party has the power to control both. SBA considers factors such as ownership, management, previous relationships with or ties to another entity, and contractual relationships when determining whether an affiliation exists. The complete definition of affiliation is found at 13 CFR 121.103, with additional information at 13 CFR 121.107 and 121.301.

Affiliation is also a concern for applicants for which a significant third party relationship is an important part of their business model, such as a franchise business or a company reselling gasoline through a ‘jobber’ agreement. A full determination of that company’s eligibility must include a review of the documents that govern such a relationship to determine whether there are elements that define ‘control’ outside the SBA’s tolerance.

“The SBA’s review of these franchise or gas jobber documents will be intended to ferret out elements or terms that will concede too much control to the third party that may place the lender and SBA at a higher risk in the event of a loan default,” said Rodgers.

How does SBA ascertain whether too much control exists? SBA is looking for basic managerial control that is sometimes inserted through innocuous contract terms that empower the third party to manage or benefit from the business to the disadvantage of the business owner.

Some of the third party control elements prohibited by the SOP include: 1) excessive restrictions on the applicant’s sale or transfer of the business, 2) insufficient access to profits commensurate with applicant’s risk of loss, 3) right to hire or fire applicant’s employees, 4) right to buy applicant’s assets at price set by third party upon cancellation of the agreement and 5) right to restrict use of future buyers of applicant’s assets. More guidance on SBA’s limitations on third party control can be found in the SOP 50 10 5 E, page 93 paragraph 9.

Individual Eligibility Determinants

Citizenship -There are restrictions and specific requirements for business owners who are non-US Citizens. At the time the application for guarantee is submitted, the lender is required to verify the legal status of an alien by completing a “Document Verification Request” using form G-845. Guidance and instructions to use this form can be found in the SOP 50 10 5 E, page 102 paragraph 5.

Statement of Personal History Form 912 – An SBA form 912 is required to be submitted for all business owners of the applicant business who have at least a 20% interest in the business. The form is also required when spouses collectively own 20% or more of the business. The agency also requires key employees to file form 912. A ‘key employee’ is defined as one who manages the day to day operations and whose dismissal or absence could adversely affect the business operations.

Personal Resource Test – The SBA cannot provide financial assistance to any applicant able to obtain reasonable, non-federal financing, including the utilization of the excess liquid assets belonging to the applicant’s owners. It is incumbent for lenders to evaluate each participating applicant to ensure that they are eligible for assistance based on the SBA’s defined ‘personal resources test.’

Rodgers explained, “Essentially the test defines the maximum liquid assets that can be owned by each business owner in three distinct categories, based on the size of the total financing package.” The limitations are as follows:

1) For total financing of $250,000 or less, each business principal is limited to no more than 2x the total financing or $100,000, whichever is greater;
2) For total financing of $250,000 to $500,000, each business principal is limited to no more than 1.5x the total financing or $500,000, whichever is greater;
3) For total financing of $500,000 or more, each business principal is limited to no more than 1x the total financing or $750,000, whichever is greater;

Of note, “total financing package” refers to the SBA loan plus any additional loans being extended at the same time and the borrower’s equity injection.

Some considerations to include in the personal resources review:

“Principals” include any sole proprietors, general partners and owners of 20% or more of the business and include interests held by spouses and dependent children.

“Liquid Assets” are cash and cash equivalents, including savings accounts, CDs,
marketable securities and the cash value of life insurance. Qualified retirement accounts such as IRAs, Keogh or 401k plans (unless the principal is over 59 ½ years of age), Health Savings Accounts or tax-advantaged educational savings are not liquid assets.

“Excess Liquid Assets” is the amount by which each principal’s liquid assets exceed the maximum liquid asset limit allowed and would have to be contributed to the business in lieu of that portion of the SBA loan.

Coleman’s Takeaway

Borrower eligibility is a fundamental evaluation that every transaction must go through, and due to many public policy concerns and legal constraints, the standards checklist has grown more lengthy and complex over the years. While most do not impact the borrower’s ultimate performance, they certainly can disrupt the lender’s ability to be paid on a loan guarantee if the agency discovers that an error was made post-default.

In recent webinar presentations, presenters have repeatedly described situations where lenders were denied guarantee repayments because they made simple errors in the rush to get approval. These became very expensive mistakes that should have been avoided.

Citations

Keep in mind that each deal is different – they are all unique and require individual review of both business and principle owner information that’s provided.

Gina Rodgers
Manager of Training and Personnel for Banc-Serv Partners, LLC

Each distinct business category defined by the North American Industry Classification System (NAICS) is assigned an eligibility limitation by SBA to determine if they are officially a ‘small’ business.

Gina Rodgers
Manager of Training and Personnel for Banc-Serv Partners, LLC

The SBA’s review of franchise documents will be intended to ferret out elements or terms that will concede too much control to the third party that may place the lender and SBA at a higher risk in the event of a loan default

Gina Rodgers
Manager of Training and Personnel for Banc-Serv Partners, LLC
Borrower eligibility is a fundamental evaluation that every transaction must go through, and due to many public policy concerns and legal constraints, the checklist of standards has grown more lengthy and complex over the years.

 

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