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SBA Releases SOP Revisions Affecting 504 Lending

Nov 2017

The Small Business Administration (SBA) has released Standard Operating Procedure (SOP) 50 10 5(J) for lender and certified development company (CDC) loan programs, including the 504 program. The new SOP becomes effective on Jan. 1, 2018.

Following is a summary of the 504 Loan Program policy changes:

Franchises: Among the biggest changes, the SBA has revised the review process for 504 loan applicants that are or will be operating under a franchise, license, dealer, jobber or similar agreement that meets the Federal Trade Commission (FTC) definition of a franchise. Now, SBA lending partners and CDCs will no longer have to review franchise or other brand documentation for affiliation or eligibility after Jan. 1, 2018.

For loans processed through Dec. 31, 2017, lending partners must continue to follow the franchise review procedures set forth in SOP 50 10 5(I) and SBA Policy Notice 5000-1941 (effective Feb. 14, 2017), and should contact franchise@sba.gov to obtain an SBA Franchise Identifier Code, if necessary.

The SBA has created and is posting a list, the SBA Franchise Directory (the “Directory”), on its website at www.sba.gov/for-lenders of all franchise and other brands reviewed by the SBA that are eligible for SBA financial assistance. The Directory includes only those brands that the SBA has determined are eligible under SBA affiliation rules and other eligibility criteria. If the applicant's brand meets the FTC definition of a franchise, it must be on the Directory in order to obtain SBA financing. (To help minimize confusion over brands that may appear to be franchises, but that do not meet the FTC definition, the SBA will include such brands on the Directory at their request if they are eligible in all other respects.) See SBA Launches New Franchise Directory; Issues Key Revisions to Franchise Review Process

Refinance without Expansion: New in the SOP: Eligible business expenses limitation has been dropped from 25% to 20%; “Other Secured Debt” is no longer eligible to be included in the refinancing project. It is eligible to allow the refinance of credit card debt if the card is issued in the name of the business, the applicant certifies to the eligible business charges, and the applicant identifies and deducts any personal charges from balance to be retired. The definition of a start-up business is now consistent with the regular 504 loan program definition.

Aggregate Financing for Each Small Business Concern: The guidance for Energy Public Policy Goals has been moved here in the new SOP. It clarifies that to be eligible for the 10% energy reduction goal, the project must be a new facility that is replacing an existing facility or a retrofit of an existing facility. A renewable energy project must generate at least 10% of the energy used by the applicant at the project. Small manufacturers (applicant and affiliates) may receive up to $5.5 million in 504 funding per project with no limit on the total dollars available. Renewable energy and 10% energy savings projects may receive $5.5 million per project, however the outstanding gross debentures issued for a small business concern, including its affiliates, must not exceed $16,500,000 in the aggregate. These amounts are NOT reduced by any other outstanding SBA financing (7a, Community Advantage, regular 504). The regular 504 limit of $5 million remains available as well.

Limited or Special Purpose Properties: Under the previous SOP, a 15% injection was required for property deemed to be special purpose or limited purpose. Effective Jan. 1, 2018, if the borrower or any affiliates has an outstanding balance on a debenture for a special propose property, any subsequent projects for limited or special purpose properties will require 20%. Regardless of whether a business (including its affiliates) has an outstanding debenture(s) for a project involving a limited or special purpose property, the minimum required equity injection will not exceed 20%.

Credit Standards: Added “The Applicant must be current on all federal, state and local taxes, including but not limited to income taxes, payroll taxes, real estate taxes and sales taxes.”

Definition of a New Business: Added “Operations are deemed to begin when the business begins generating revenue from its intended operations.”

Borrower's Contribution: Clarified sources of borrower contribution - cash (or property acceptable to the SBA obtained with the cash) or land (that is part of the project property). If a borrower (including affiliates) has more than one project that is a limited or special use asset, the borrower must contribute 20% for each project after the first one.

Size Determination and Affiliation: New language was added regarding affiliation. Affiliation based on management has been clarified to state that if the officers, managing members or partners who control the management (or the Board of Directors) of the applicant also control the management (or Board of Directors) of one or more concerns, affiliation arises. Management control can also arise through a management agreement. Management agreements that give the management company sole discretion over business operations with minimal oversight of the decision-making by the applicant create affiliation between the management company and the applicant business. However, affiliation does not exist if the management agreement includes meaningful oversight by the applicant business over the management company's activities.

Meaningful oversight includes all of the following:

• Approve the annual operating budget;

• Approve any capital expenditures or operating expenses over a significant dollar

• Threshold;

• Have control over the bank accounts; and

• Have oversight over the employees operating the business (employees must be the

• Applicant's employees).

Management Agreements: Management agreements must be submitted to determine if they create affiliation. Information about management agreements is covered under the franchise section as a reminder that the management agreement review and approval process extends to Applicants that are operate under franchise agreements that may also choose to utilize the services of a management company. Both relationships require SBA review and approval.

Credit Elsewhere: The SBA has expanded the credit elsewhere test. The prior test was limited to the applicant's ability to obtain a loan on reasonable terms without a Federal government guaranty, and the applicant's ability to obtain funds from the resources of the applicant business. The new SOP expands these into two broad categories:

• “Sources related to the applicant” which now includes the liquidity of owners, spouses, guarantors, associates, and the applicant business; and

• “Sources unrelated to the applicant” which includes conventional lenders or other sources of credit (i.e. a commitment from a franchisor).

Substantiation that credit is not available elsewhere by discussing weaknesses in the credit must include specific reasons why the applicant does not meet the lending partner's conventional loan policy requirements. The four specific acceptable factors remain unchanged. Meeting CRA requirements continues to be an unacceptable factor.

Passive Businesses: Examples of passive businesses now includes salon suites and similar business models that generate income by renting space to accommodate independent businesses that provide the personal services. Businesses that have entered into a management agreement that gives the third-party management company sole discretion to manage the operations of the business are considered passive and not eligible. The wording has been changed on businesses engaged in leasing equipment, household goods or other items from “are” eligible to “may be” eligible. The same change from “are” eligible to “may be” eligible has been made for barber shops, hair salons, nail salons, and similar types of businesses.

912 Processes: The SOP has been updated to reflect the new 912 processes. Item 13 1) and 2) clarify that the SBA cannot make loans to (1) individuals incarcerated, on probation, on parole, on deferred prosecution; or (2) if the individual is subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought by in any jurisdiction.

Businesses Owned by Non-Immigrants: Specific information is provided about the types of visas and what is required for a non-immigrant to live and work in the United States legally. The following classes of non-immigrant aliens may be eligible for SBA assistance - USCIS entrepreneur guide non-immigrant visa categories:

• B-1 business visitor;

• F-1/OPT optional practical training;

• H-1B specialty occupation;

• E-2 treaty investor; and

• L-1 intracompany transferee.

EPC Rule: The significant change is the ability to finance the change of ownership between existing owners of an EPC as long as the real estate has been held by the entity for at least 36 months. Also, the loan proceeds may be used to finance a stock or ownership purchase if the underlying assets are limited to real estate and/or other eligible long-term fixed assets. Ineligible assets (such as escrow accounts, replacement reserves, etc.) must be directly related to the eligible long-term fixed assets, must be de minimis, and may not be included in the project financing. EPCs: There may be multiple OCs separately owned; however, only one EPC is permitted per transaction.

EPCs and Spousal Guarantees: The language has been changed related to spousal guarantees. If the combined ownership of spouses in the EPC or OC totals 20% or more, both spouses must guarantee. The 5% minimum ownership by one spouse has been eliminated in this section.

Residential Space: The residential space may be occupied by the business owner or leased to a third party. Occupancy by the business owner does NOT constitute business occupancy unless it meets the “essential to the business” test.

Leasing Part of the Project Building: The SOP clarifies that loan proceeds may not be used to renovate any of the property rented to a third party. New: The borrower may NOT lease any of the property to any business engaged in any activity that is illegal under federal, state or local law (i.e., a marijuana dispensary) during the life of the loan.

Appraisals: The SBA clarified that the appraisal must be dated no more than 12 months prior to the date of application.

Appraisals (LTV): The SBA increased the threshold for an acceptable minimum appraised value from 90% to 95% of estimated value without requiring a reduction in the debenture, additional collateral or additional investment from the borrower.

For more information about SBA 504 loans in Florida, South Alabama or South Georgia,contact aFlorida First Capital Loan Officeror email us atinfo@ffcfc.com. Phone: 850.681.3601 or toll-free at 888.320.5504.