Major Rule Change from the SBA!

The Small Business Administration (“SBA”) has recently published major rule changes related to its lending and affiliation criteria for its business loan programs. These rules will radically change the basis of SBA lending and are scheduled to take effect in mid-May of this year. Outlined below are the three most significant changes applicable to business owners and aspiring entrepreneurs.

1. Partial Change of Ownership (13 CFR 120.130)

Instead of requiring a complete change of ownership, the SBA rules will now allow 7(a) loan proceeds to fund partial changes of ownership. This means that an applicant may now use a loan to purchase a portion (or the entirety) of an owner’s interest in a business. This will open the doors for entrepreneurs looking to partner with business owners and for business owners interested in providing ownership incentives to their employees.

2. Underwriting Criteria (13 CFR 120.150)

Instead of analyzing nine specific lending criteria to determine an applicant’s creditworthiness and reasonable repayment assurance, the SBA, Lenders (as defined in § 120.10), and Certified Development Companies may consider any of the three following criteria individually or in any combination: (a) The credit score or credit history of the applicant, its associates and any guarantors; (b) The earnings or cashflow of the applicant; or (c) Any equity or collateral of the applicant (if applicable). The new rules also require that Lenders use “appropriate and prudent generally acceptable commercial credit analysis processes and procedures consistent with those used for their similarly-sized, non-SBA guaranteed commercial loans.” Essentially, Lenders will now be required to underwrite SBA loans in the same manner as they would underwrite similarly-sized, non-SBA guaranteed commercial loans.

3. Affiliation (13 CFR 121.301)

The SBA will also be making a number of changes to its affiliation criteria for determining the size of an applicant for purposes of SBA loan eligibility. Affiliation based on the principal of control will be removed as a basis for finding affiliation. Accordingly, affiliation will no longer be based on management, identity of interest, or franchise and license agreements. Instead, ownership will determine affiliation. Businesses or individuals will be considered affiliated for SBA loan purposes in the following circumstances:

1. If the business owns more than 50% of the applicant or the applicant owns more than 50% of the business;
2. If an owner of more than 50% of the applicant owns more than 50% of another business in the same 3-digit NAICS subsector, then the applicant, the owner, and the same subsector business are all affiliates; or
3. If no owner owns more than 50% of the applicant, any owner of 20% or more of the applicant that is either a business in the same 3-digit NAICS subsector, or that owns more than 50% of another business in the same 3-digit NAICS subsector, than the applicant, owner, and same subsector businesses are affiliates.

*For purposes of determining amount of ownership: (i) the ownership interests of spouses and minor children will be combined; and (ii) stock options, convertible notes, and merger agreements will be given present effect.

To review the full SBA rules and for more information regarding any additional changes please visit: https://www.regulations.gov/document/SBA_FRDOC_0001-0447