SBA 504 Updates The biggest change for SBA 504 lending is on the underwriting side: The minimum debt service coverage ratio increased from 1.00:1 to 1.15:1. Prior SBA policy required business tax returns and current year interim financial statements. Now SBA is asking for the highest level of financials available as well. In addition, the SBA also provides more detailed guidance on global cash flow, including how to account for distributions, owner compensation, unfunded capital expenditures and fully drawn lines of credit. For SBA 504 loans with a total project cost of $5 million or more, CDCs will also need to obtain and incorporate the third-party lender’s underwriting analysis into the CDC credit memo. In other words, expect a little more rigor around the numbers and a closer look at the full credit picture. Specifics on the third-party lender loan went into effect as well. The maturity of the third-party loan cannot exceed the SBA 504 debenture term, and its amortization cannot exceed that of the SBA 504 loan. The new SOP clarifies that businesses are ineligible when the owner isn’t actively controlling operations, including assigned-space revenue models or leveled models, in which a small business relies on a middle-level operator and doesn’t own the necessary contracts to operate. There are some meaningful opportunities in the update, too. SBA has removed the $16.5 million aggregate cap on outstanding eligible energy projects, while the maximum debenture remains $5.5 million per qualifying energy project. The new SOP also incorporates previously issued guidance that allows borrowers to finance multiple SBA 504 projects simultaneously and confirms that the SBA 7(a) guaranty exposure no longer reduces the maximum SBA 504 debenture available. For construction projects, the allowable contingency increases from 10% to 15% of construction costs. What does this mean for lenders? More opportunities to bring SBA 504 loans into the conversation, particularly for borrowers with expansion, energy or multiple fixed-asset financing needs — but with a higher bar for underwriting and documentation. It’s worth getting familiar with the changes now so you can spot SBA 504 opportunities early, structure them correctly and bring B:Side into the conversation before the deal is too far down the road. SBA 7(a) Updates The SBA 7(a) program sees its own round of changes, starting with documentation. Credit reports and personal financial statements must now be dated within 90 days, rather than 120 days, and credit reports must be submitted to the SBA. Lenders will also need to use the three most recent year-end financial statements and the highest level of financial reporting available, along with the most current interim financial statement and the comparable interim financial statement from the previous year, for change-of-ownership transactions. If a trust owns any percentage of the borrower, both the trust and the trustor must guarantee the loan. Business acquisitions face a higher underwriting bar and are one of the biggest changes under the new SOP for SBA 7(a) financing. Lenders can no longer rely on projections to meet the DSC standard, and the SOP establishes specific requirements for initial acquisitions, business expansions and owner buyouts. The minimum DSC is 1.25:1 for initial acquisitions and owner buyouts, and 1.15:1 for business expansions. Initial acquisitions also require a minimum 10% equity injection of the total project. The SOP also adds requirements around partial ownership changes, seller guarantees and seller financing, including a 36-month seasoning requirement for seller-financed notes before they can be refinanced. Change-of-ownership transactions also require a third-party business valuation and a quality-of-earnings report for projects of $3 million or more. The seller’s exit period can extend to 24 months, up from 12 months, while buyer rebates must be applied to pay down the loan. Projects that include real estate can be structured as separate loans or blended on a weighted average. There are some other notable updates, including new restrictions on non-cash sources of equity, additional requirements for minority equity investments, and 17
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