Keeping It Simple: SBA Policy Notice 5000-17057

On April 3, 2018, the Small Business Administration (“SBA”) released Policy Notice 5000-17057 (the “Notice”), which immediately became controlling over any conflicting provisions in Standard Operating Procedure 50 10 5(J). The Notice revised guidance on the credit elsewhere test, minimum equity requirements for change of ownership transactions between existing owners, and provides guidance related to ineligibility of businesses engaged in illegal activity. The following is a brief summary of the most important Notice sections:

Credit Elsewhere and Owner Liquidity: The Notice requires lenders to consider the liquidity of owners of 20% or more of the applicant business. The subject policy notice increases the minimum percentage ownership consideration from 10% to 20%. When determining owner liquidity, the liquid assets of the owner’s spouse and minor children are included in the analysis.

Equity Requirements for Changes of Ownership Between Existing Owners: Under the new guidance, SBA 7(a) loans can only finance up to 90% of a partner buyout unless: (1) “the remaining owner(s) . . . certify that he/she has been actively participating in the business operation and held the same ownership interest in the business for at least the past 24 months (Lender must include in the credit memorandum confirmation that the borrower has made the required certification and retain such certification in the loan file); and (2) the business balance sheets for the most recent completed fiscal year and current quarter . . . reflect a debt-to-worth ratio of no greater than 9:1 prior to the change of ownership.”  If (1) and (2) are not satisfied, the remaining owner(s) must contribute cash in the amount of at least 10% of the purchase price of the business, as shown in the purchase and sale agreement. 

Ineligibility of Businesses Engaged in Illegal Activity that is Illegal Under Federal, State, or Local Laws: The Notice provides guidance regarding businesses that derive revenue from, and/or support the end-use of marijuana. For both 7(a) and 504 loans, the Notice dictates that marijuana-related businesses (whether direct or indirect) and hemp-related businesses remain ineligible for SBA financing. This ineligibility also prohibits the borrower from leasing any portion of a building acquired with SBA funds to a business that is illegal under federal, state, or local law. The following are descriptions for the subject ineligible types of businesses directly from the Notice:

“Direct Marijuana Business” - a business that grows, produces, processes, distributes, or sells marijuana or marijuana products, edibles, or derivatives, regardless of the amount of such activity. This applies to personal use and medical use even if the business is legal under local or state law where the applicant business is or will be located.

“Indirect Marijuana Business” - a business that derived any of its gross revenue for the previous year (or, if a start - up, projects to derive any of its gross revenue for the next year)) from sales to Direct Marijuana Businesses of products or services that could reasonably be determined to support the use, growth, enhancement or other development of marijuana. Examples include businesses that provide testing services, or sell grow lights or hydroponic equipment, to one or more Direct Marijuana Businesses. In addition, businesses that sell smoking devices, pipes, bongs, inhalants, or other products that may be used in connection with marijuana are ineligible if the products are primarily intended or designed for such use or if the business markets the products for such use.

“Hemp-Related Business” - a business that grows, produces, processes, distributes or sells products purportedly made from “hemp” is ineligible unless the business can demonstrate that its business activities and products are legal under federal and state law. Examples of legal hemp products include paper, clothing and rope.

The SBA is reviewing the aspects described within the Notice and will update the Standard Operating Procedures once it has determined whether additional clarifications are needed. For more information on the Notice or other commercial lending matters, send an e-mail to me at [email protected].