You have questions, we have answers! To keep you informed and help you navigate through the SBA process, this Q&A section will keep you in-the-know and give you answers when you come across these questions and issues in your 7(a) loan projects.
This month, we take on questions regarding:
- Equity Injections
- SBA Audits
- Tax Verification Requirements
- Lease Requirements
Question #1:
Q: For an expansion or building construction (not an acquisition) what is the equity/cash requirement? Does building type matter, meaning special use (like in 504, where that adds 5% to the injection %)? Is there even an SBA requirement for equity in expansion, or building construction situation?
A: On the 7(a) side, SBA currently only requires an equity injection (10%) if financing a change of ownership and the loan will be over $500,000. For any 7(a) loan up to $500,000, SBA leaves the decision on whether to require an equity injection (and if so, how much) up to the business judgment of the Lender.
For 7(a) loans over $500,000 that are not financing a change of ownership, the bank is required to follow its equity injection requirements for similarly-sized non-SBA loans. However, the bank may use its discretion to reduce the amount of equity injection required if it determines the Applicant needs leverage that exceeds the bank’s conventional requirements. For example, if the conventional requirement would be 20% and the borrower does not have that much, you would explain in the credit presentation what the equity injection will be and why the bank believes that level is prudent.
Question #2:
Q: We are going through an audit of our SBA program. Here are a couple questions I was hoping you could help with as our LSP:
- Evidence of the SAM Exclusions search for the Lender Service Provider and the LSP’s employees that provide services to your entity related to processing, closing, servicing, or liquidating 7(a) loans or have access to the corresponding data.
- Within the last 18 months, there has been one or more internally or externally prepared oversight/examination reports/audits on the LSPs performed?
- The only situation where the LSP can receive compensation from both the Lender and the Applicant is when the LSP provides different services by providing packaging services to the Applicant and receiving a referral fee from the Lender. (True or False)?
A: Regarding the first bullet point, WBD can provide sam.gov searches for WBD Service Company and our team who provides LSP services upon request.
Regarding the second bullet point, SBA appears to be incorporating more oversight of LSPs since the beginning of 2024. All new executed agreements require an LSPA Submission Letter. Within the content of that letter are questions SBA feels are pertinent to a lender's LSP relationship with WBD.
The most important aspect here is WBD has been doing business with community banks in WI for 40 years and we are well respected by SBA (within the top 10 CDCs in 504 volume). WBD’s team has significant knowledge in SBA 7(a) lending and we document all training we participate in. Typically we have not shared that information but we could compile something if that would be useful for your institution. SBA has also suggested that lenders visit the office of their LSP to make sure that it’s legitimate business. Additionally, when asked, WBD will typically share financial and other compliance information with lenders who request it for vendor management purposes. Here are a couple links to our website - one that includes our annual reports (no financial information included) and the other dedicated to our 7(a) Lender Services program:
https://www.wbd.org/wbd-lender-services
Regarding the third bullet point, that statement is true; however, in practice WBD does not receive LSP compensation from both the lender and applicant business. We only receive LSP compensation from the lender.
Question #3:
Q: We are working on a business acquisition where the income and expenses of a business being purchased was combined with another entity that the seller owns. Our borrower is only purchasing one of the businesses. How do we handle this from a tax return verification standpoint?
A: For a change of ownership, the SBA Lender must verify the seller’s financial data, including a selling sole proprietor’s Schedule C, except as noted below.
- When there is an acquisition of a division or a segment of an existing business, the SBA Lender may use alternative forms of verification from third-party sources, such as sales tax payment records, data aggregation services, credit reporting services, etc., to verify the seller’s financial data.
- The requirement to verify seller’s financial data does not apply to 7(a) loans $500,000 or less or to 504 projects $500,000 or less; instead, for these loans, Lenders and CDCs must use the same policies and procedures to verify seller financial data that they use on their similarly-sized, non-SBA guaranteed loans. The SBA Lender must discuss in its credit memorandum how the SBA Lender verified business revenue.
So if the 7(a) loan amount will be $500,000 or less, you would follow the bank’s policies and procedures for verifying the seller’s financials on a similarly-sized non-SBA commercial loan. If the 7(a) loan will be over $500,000, then SBA requires verification of the seller’s financials using a 3rd party source. Obtaining accountant-prepared (not internally-prepared) financials for the two entities that reconcile back to the tax returns that are verified against IRS transcripts would meet that requirement.
As an alternative for a 7(a) loan over $500,000, if the business pays sales tax on its revenues, you could obtain copies of their sales tax payment reports to the state for the two entities and reconcile those back to the revenues on the tax returns that are verified against IRS transcripts. In that case, accountant-prepared financials would not be required.
BONUS QUESTION!
Q: Can you please advise on when a lease is and isn't required in 7(a) lending? I feel like the requirements have changed since we last used the program.
A: SBA Notice 5000-852522 was effective 12/6/23, which made several updates to SOP 50 10 7.1. The following is from the bottom half of page 1 and references lease requirements:
- When the Borrower is operating in leased space and when a substantial portion of the loan proceeds will be used for leasehold improvements or a substantial portion of the collateral consists of leasehold improvements, fixtures, machinery, or equipment that is attached to leased real estate:
- The SBA Lender must obtain a copy of the written lease between the Borrower and the landlord. For 7(a) loans, the lease term, including renewal options exercisable only by the Borrower, should equal or exceed the term of the loan. For 504 loans, the lease term must equal or exceed the term of the loan. An assignment of lease and Landlord’s waiver should be obtained.
- If the SBA Lender is unable to obtain the assignment of lease or landlord’s waiver, for both 7(a) and 504 loans, the lease term, including renewal options exercisable only by the Borrower, must equal or exceed the term of the loan. Additionally, the SBA Lender must document its file with the attempt to obtain the assignment and the landlord’s waiver and the reason(s) for not providing it.”
The underlined words - Substantial, Must, Should and Additionally will help you understand SBA’s requirements. In this context, SBA has verbally defined Substantial as at least $500,000 or 30% of loan proceeds being used for leasehold improvements, whichever is less; or at least $500,000 or 30% of collateral value consisting of assets attached leased real estate, whichever is less. Assuming that is the case, then following are SBA’s requirements:
- First, the lender must obtain a copy of the written lease between the Borrower and landlord. The lease term, including renewal options exercisable only by the Borrower, should equal or exceed the term of the 7a loan. And an assignment of lease and landlord’s waiver should be obtained.
- But if the lender is unable to obtain an assignment of lease or landlord’s waiver, then the lease term, including renewal options exercisable only by the Borrower, must equal or exceed the term of the 7a loan. And the lender is required to document the loan file with the attempt to obtain the assignment of lease and landlord’s waiver, and their reason for not providing it.
So if you obtain an assignment of lease and landlord’s waiver, then it would be acceptable for the lease term to be less than the 7a loan term. Conversely, if the lease term is at least as long as the 7a loan term and you are unable to obtain an assignment of lease or landlord’s waiver, that would also be acceptable if you document the loan file accordingly.
