SBA Loan Guarantees – New Equity Injection Rule

With the release of the SOP 50 10 5(C), which goes into effect on October 1, 2010, the SBA has revised the SOP to provide a specific list of documents required to be obtained by a Lender as adequate proof of equity injection. The requirements to document a cash equity injection are as follows:

1. A copy of a check or wire transfer along with evidence that the check or wire was processed showing the funds were moved into the borrower’s account or escrow;

2. A copy of the statements of account for the account from which the funds are being withdrawn for each of the two most recent months prior to disbursement showing that the funds were available; and

3. A subsequent statement of the borrower’s account showing that the funds were deposited or a copy of an escrow settlement statement showing the use of the cash.

It is important to note that SBA has not included in its requirements for documenting a cash injection, the prior distinction between a “material” injection (which required lenders to prove the source of the injection) and a “non-material” injection (which did not require lenders to prove source). Apparently, under the new SOP, proof of the source of a cash injection is always required. The Section further goes on to state that a “promissory note, ‘gift letter’ or financial statement” by themselves will not be considered sufficient documentation of equity injection, unless they are obtained in conjunction with the documentation set forth above.

The new SOP 50 10 5(C) also changed what is required when assets other than cash are being used for equity injection. Therefore, beginning October 1, lenders are required, instead of it being merely recommended, to obtain an appraisal or other independent third party valuation “if the valuation of the fixed assets [to be injected] is greater than the depreciated value (net book value).” The SBA further indicates that the required fixed asset valuation cannot be contained in a general business valuation obtained by the lender unless the valuation is part of a “going concern appraisal”.

Lastly, the new SOP 50 10 5(C) has changed its stance on borrowed equity funds, but only in relation to 504 loans, not 7(a) loans. Until now, under both the 7(a) and 504 programs, borrowed equity funds would only be allowed if borrower could demonstrate that it could repay the borrowed funds from sources other than the cash flow from the business and/or the salary of the business owner.

As of October 1, borrowed equity will be allowed to be considered towards equity injection in the 504 program if borrower can demonstrate that it can repay the debt from “the cash flow of the business or other sources.

Notwithstanding this change, the borrowed equity injection requirements under the 7(a) program remain the same (Borrower must demonstrate repayment ability from outside sources only). Regardless of the type of equity injection involved, Lenders should avoid a “checkbox mentality” towards ensuring the adequacy of the proof of injection. A detailed, thoughtful review of the documentation provided to prove the source and existence of the equity injection may be the difference between the SBA honoring the guaranty and a repair or denial.

Courtesy Steve Chaker, Pacific Alliance Bank (213-880-5136)

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