SBA Hot Topic Tuesday — Understanding SBA’s EPC/OC Rules

July 11, 2017

By Walter H. McLaughlin

SBA Hot Topic Tuesday — Understanding SBA’s EPC/OC Rules

Of the many positives SBA financing provides Main Street, one of the most important is the ability to purchase owner-occupied properties on reasonable terms and rates. Through the 504 and 7(a) programs, eligible small businesses can preserve much-needed capital for day-to-day operations or future growth while obtaining all the advantages of real estate ownership.

For borrowers pursuing an SBA loan, vesting is critical because the eligibility glide path is narrow. After all, the 50 10 5 specifically prohibits loans to “passive businesses owned by developers and landlords” while at the same time, tax professionals often advise that the principals set up a holding company, which is which is both passive and a landlord. Fortunately, SBA resolves this potential conflict through its EPC/OC rules.

How does it all work?


Outlined on page 99 of the 50 10 5 (I) are the specifics of an EPC:

1. Conditions necessary to qualify as an EPC. (13 CFR §120.111)

a) Under SBA regulations, an EPC can take any legal form or ownership structure. A tenancy in common is a form of legal ownership and does not create a new or separate legal entity. If authorized by state law, legal entities can be a tenant in common with individuals.

There are occasions where individuals own the real estate and lease it to the operating company. That’s allowed, as is anything else that passes legal scrutiny and SBA’s eligibility criteria. Take note that although multiple OCs are fine, only one EPC per transaction is permitted.

b) An EPC must use loan proceeds 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 (OC) for conducting the OC’s business. An EPC may not use loan proceeds to acquire a business, acquire stock in a business or any intangible assets of a business or to refinance debt that was incurred for those purposes.

Notice that it specifies real or personal property and mentions eligible refinancing. That means equipment financing can fit within the EPC/OC rule, as can paying off certain debt. Change of ownership is ineligible.

2. Conditions that apply to all legal entities:

a) The OC must be an eligible small business;
b) The proposed use of proceeds must be an eligible use as if the OC were obtaining the financing directly, subject to paragraph 1.b) above;
c) The EPC (with the exception of a trust) and the OC each must be small under the appropriate size standard of 13 CFR Part 121.

The Operating Company (OC) must be eligible, as do the uses of proceeds. Both the EPC and OC have to fall within SBA size standards.

The following are a number of key requirements:

  • There must be a written lease, with a term—including options exercisable by the OC—at least equal to the loan term.
  • The lease must be subordinated to the SBA’s security interest(s) and the EPC must agree to an assignment of rents.
  • The OC is required to lease 100 percent of the square footage from the EPC, but may sublease portions of the building provided the square footage conforms to the occupancy rules on page 111 of the SOP.
  • The proposed rent/lease payments cannot exceed an amount necessary to cover loan payments, taxes, insurance and reasonable maintenance.
  • An EPC (including a trust) may engage in a business activity other than leasing the property to the OC.

Size standards

If the EPC and OC are affiliated, combine the two in the size standard calculations. If unaffiliated, each must fit within the size standards individually. Affiliation impacts how multiple OC situations are analyzed as well.

Naturally, all other potential affiliations are to be considered.

Uses of proceeds and guarantees

For typical real estate purchase/refinance transactions, an EPC and OC can either be borrower/guarantor or co-borrowers. If there are proceeds earmarked for working capital or other uses by the OC, the loan must be structured with the two as co-borrowers. Owners of 20 percent or more of each entity must guarantee the loan.

Credit Elsewhere Test

As with all types of SBA loans, the transaction must meet the “Credit Elsewhere Test”. Make sure your file is documented appropriately.

That’s a quick summary of the SBA EPC/OC rules. As always, be sure to explore all aspects of a deal to uncover any unique elements, as the SOP says the rules will be interpreted strictly. As Paracelsus wrote in 1538, “The interpretation of dreams is a great art.”