August 29, 2017
By Bob Coleman
Editor, SBA Hot Topic Tuesday
SBA Hot Topic Tuesday — Financing the Change of Ownership in an EPC
SBA’s last week published Federal Register notice contains a cleanup of language and clarification of rules.
Most are minor changes. However, SBA will now allow SBA financing for change of ownership in eligible passive companies.
Eligible passive companies are used by the owner or owners of a small business to allow them to obtain SBA financing to acquire real estate in an entity separate from their small business.
SBA does not intend for this regulation to be used to finance a change of ownership in an EPC that has only been in existence for a limited period of time.This regulatory change is intended to assist with the preservation of a business that might otherwise cease operations due to the departure of an owner, as opposed to simply facilitating the withdrawal of capital out of the business.
In the 504 Loan Program, the amended regulation will permit loan proceeds to be used to finance a change of ownership in the EPC when the assets of the EPC are limited to real
estate and/or other eligible long-term fixed assets that the EPC leases to one or more Operating Companies for conducting the OC’s business.
SBA recognizes that an EPC’s balance sheet may include limited assets in addition to the real estate or other eligible longterm fixed assets, such as capital replacement reserves or escrow
accounts for taxes and/or insurance (such assets are referred to in this discussion as ‘‘ineligible assets’’).
In such case, 504 loan proceeds may be used to finance a change of ownership between existing owners of the EPC as long as (1) the ineligible assets are directly related to the real estate or other eligible long-term fixed assets, (2) the amount attributable to such ineligible
assets is de minimis, and (3) the ineligible assets are excluded from the Project financing.
SBA clarifies that rent or lease payments made by the OC to the EPC cannot exceed the
amount necessary to make the loan payment to the lender, and additional amounts to cover the EPC’s direct expenses of holding the property, such as maintenance, insurance and property
While SBA permits eligible EPCs to hold certain assets financed for the benefit of the OC, it is not the intent of SBA to permit the EPC to profit from its relationship with the OC.
Following is the new adopted language from the CFR. Note further guidance will be available when SBA updates the SOP 5010.
What conditions must an Eligible Passive Company satisfy?
An Eligible Passive Company must use loan proceeds only to acquire or lease, and/or improve or renovate, real or personal property (including eligible refinancing), that it leases to one or more Operating Companies for conducting the Operating Company’s business, or to finance a change of ownership between the existing owners of the Eligible Passive Company.
When the Operating Company is a co-borrower on the loan, loan proceeds also may be used by the Operating Company for working capital and/or the purchase of other assets, including intangible assets, for the Operating Company’s use as provided in paragraph (a)(5) of this section. (References to Operating Company in paragraphs (a) and (b) of this section mean each Operating Company.) In the 504 loan program, if the Eligible Passive Company owns assets in addition to the real estate or other eligible long-term fixed assets, loan proceeds may not be used to finance a change of ownership between existing owners of the Eligible Passive Company unless the additional assets owned by the Eligible Passive Company are directly related to the real estate or other eligible long-term fixed assets, the amount attributable to the additional assets is de minimis, and the additional assets are excluded from the Project financing. Any ownership structure or legal form may qualify as an Eligible Passive Company. Any ownership structure or legal form may qualify as an Eligible Passive Company.
(3) The lease between the Eligible Passive Company and the Operating Company must be in writing and must be subordinate to SBA’s mortgage, trust deed lien, or security interest on the property. The Eligible Passive Company (as landlord) must furnish as collateral for the loan an assignment of all rents paid under the lease. The rent or lease payments cannot exceed the amount necessary to make the loan payment to the lender, and an additional amount to cover the Eligible Passive Company’s direct expenses of holding the property, such as maintenance, insurance and property taxes;
EPC and the Personal Guaranty
(6) Each holder of an ownership interest constituting at least 20 percent of either the Eligible Passive Company or the Operating Company must guarantee the loan. The trustee shall execute the guaranty on behalf of any trust. When deemed necessary for credit or other reasons, SBA or, for a loan processed under an SBA Lender’s delegated authority, the SBA Lender may require other appropriate individuals or entities to provide full or limited guarantees of the loan without regard to the percentage of their ownership interests, if any.