There is a long history of SBA policy changes related to its various programs including change of ownership loans. Business appraisals were not always required, but the importance of independent assessments of value has grown over the years due to relatively high default rates and even cases of fraud and abuse of related programs.The following series of “policy notices” (now referred to as “Information Notice”) help to shed light on this evolution of SBA policy, beginning in 2000 and culminating in 2009. Note that each of the major policy documents within the SOP 50-10 series can be obtained in full at www.sba.gov via their online search engine. The following link contains all SOP’s related to SBA lending:
http://www.sba.gov/tools/resourcelibrary/sops/index.htmlThe historical evolution of these standard operating procedures is summarized here, following the movement from SOP50-10(4) all the way through to the most recent SOP50-10(5)(B) publication.
Information Notice 5000-677
Information Notice 5000-764
Information Notice 5000-1096
Information Notice 5000-1121
SBA Laws and Regulations
In general, each subsequent SOP version replaces the prior SOP version. Nonetheless, the prior SOP’s are helpful in terms of understanding the types of changes made by SBA personnel and also aid in understanding their “view of the world” with respect to change of ownership loans and business valuations.
Published August, 2000 During SOP50-10(4)
Loans to Finance Changes of Ownership
SBA has learned that some applications for SBA-guaranteed loans to finance a "change of ownership" may have contained erroneous financial information. The Agency is concerned with: overstated valuations of the businesses being purchased; overstated valuations of the collateral being offered; and/or incorrect depiction of the business’s historical cash flows. When these circumstances were found to exist, the applicants were generally convenience stores and the applications were prepared by loan packagers.
Change in Policy and Procedures
The purpose of this Notice is to put into place temporary measures intended to limit lender and SBA risk from circumstances such as those described above. In addition, SBA is requesting that lenders exert a high level of due diligence when reviewing any information submitted in connection with a loan application that has been prepared by a loan packager, particularly when that information is being used to support a change of ownership.
Effective immediately, lenders have two (2) options for processing an application for an SBA 7(a) loan guaranty where any portion the proceeds will be used to purchase an existing business:
Through the SBA district or branch office that has responsibility for the territory in which the business is located; or
Through the lender’s authority to use any of the expedited processing procedures (i.e., PLP, SBAExpress, and LowDoc) for such loans. However, the lender will be held to a higher standard of due diligence care in its analysis of each case (see below). In its review of both failed loans and compliance, SBA will review the case to ensure that the lender took the steps required below to consider whether denial of liability is appropriate.
SBA will reconsider these options in 6 months. For either of the above options, when considering applications where any portion of the loan proceeds will be used to finance a change of business ownership, lenders and SBA field staff must:
Review and closely follow SBA policy and the procedures detailed in SOP 50 10(4), “Processing Function,” Subpart B, Chapter 1, paragraph 3 titled “Restrictions on Change of Ownership Situation,” page 193 - 199. Lenders and SBA staff must pay particular attention to determine that:
The change of ownership is an arms-length transaction,
The lender, or a qualified independent individual, determines the value of the small business, and
The loan file is well documented regarding the valuation and includes the substantiating analysis. This is especially true if the valuation provided by a packager or other third party appears high for the type or place of business. The lender may utilize the valuation methods recommended by SBA and discussed in the SOP to value the business being reviewed.
Obtain two (2) appraisals, including one requested directly by the lender if the business has been transferred within 36 months of the date of loan application
Verify the historical profit and loss statements of the business for the last 2 years.
Verify the last year’s income tax return from the business.
Exercise prudent lending practices to ensure that commercially reasonable steps are taken to limit risk of loss on the loan.
If any change of ownership loan sold into the secondary market defaults, the lender will be subject to an immediate PLP review. If such review indicates that the requirements of this Notice were not adhered to in the remainder of the lender’s PLP portfolio, termination of PLP status may result. This policy will be evaluated in 6 months.
Lenders must ensure that agents provide SBA with a compensation agreement. SBA believes that loan packagers provide valuable services to both lenders and borrowers. We recognize that only a very small number of loan packagers abuse the trust and confidence afforded them by both borrowers and lenders. However, in order to minimize the potential for abuse, it is critically important that SBA have accurate information regarding loans that are prepared by outside agents. Therefore, lenders must be reminded that the Code of Federal Regulations, 13 C.F.R. § 103.5, requires that every "Agent" or "Packager" (see definitions in 13 C.F.R. § 103.1) execute and provide to SBA a compensation agreement setting forth the compensation charged and services rendered to applicants or lenders in any matter involving SBA assistance. Field offices must review lender compliance with these disclosure requirements at the time of loan purchase. If it appears that a packager has been involved in the preparation of the application and the use of a packager was not disclosed, SBA expects the lenders to ask the applicant about the source of the application material. Lenders and SBA field staff should review their existing SBA Portfolios to identify potentially problematic loans. When considering requests for loan purchases, SBA staff should pay particular attention to loans that have defaulted within the first year after final disbursement. They should be carefully reviewed to determine whether packager involvement in the application could have resulted in inaccurate information to support the loan request. Similar consideration should be given when handling routine servicing actions. When it appears that irregularities may exist in the application or loan file, SBA staff should promptly refer the loan to the Office of the Inspector General (OIG). In addition, SBA staff should encourage lenders to conduct similar reviews of their portfolios, and to refer any possible problems to the local SBA office and to the OIG. Lenders are required to perform the underwriting function for all SBA guaranty loans.SBA has always taken the position that the responsibility for underwriting a request for financial assistance and determining the credit merits of any application rests with the participating lender, and not with the agent of such lender. While SBA recognizes that a lender may contract with a third party to assist applicants in the preparation of loan documents and/or accept applications prepared by independent third parties, the ultimate responsibility for the underwriting continues to rest with the lender. A participant is provided no authority to abdicate their underwriting responsibilities to an independent third party for any loan guaranteed by SBA.
Questions regarding this notice should be directed to James Hammersley at (202) 205-7505. _____________________________ Aida Alvarez Administrator Expires: 8-1-2001
Published Late 2001 During Reign of SOP50-10(4)
SBA Policy Notice
Loans to Finance Changes of Ownership Renewal of Policy Notice 5000-693
The purpose of this Notice is to renew Policy Notice 5000-693. The policy guidance in that Notice has not been modified. At this time, we are continuing to study this issue and to review the feedback from program participants prior to making a final policy decision. SBA issued Policy Notice 5000-693 putting into place temporary measures intended to limit lender and Agency risk on loans to finance "changes of ownership." The following is a reprint of Policy Notice 5000-693.
Loans to Finance Changes of Ownership Renewal of Policy Notice 5000-693
Determining the value of a business is the key component to the analysis of any loan application for a change of ownership. This requirement can be found in Subpart A, Chapter 3 of SOP 50 10. The need for an accurate valuation is true regardless of whether the financing is structured as an asset purchase or a business purchase. The lender must do its own valuation of an applicant. This is true regardless of how many other business valuations may have been performed by other interested parties. If the lender uses a series of “in-house” business valuation methods for its non-SBA loans, it should also use them for its SBA loans, and should document this process in the SBA loan file. Lenders seeking SBA guidance on business valuation methods used by SBA can contact the local district office and be given relevant pages of SOP 50 14, Training Case Book II for Processing Loan Officers. Lenders should use at least two methods to establish a range of values for the business.
Verification of Information
Notice 5000-677 requires that lenders “verify the historical profit and loss statements of the business for the last 2 years.” This was included to highlight the requirement in SOP 50 10, Revision 4, Subpart B, paragraph 3c; and Subpart A, Chapter 6. These SOP requirements remain in effect. The reference to 2 years was included to emphasize the review in connection with the reasons for the issuance of Policy Notice 5000-677. Verification of the information will be accomplished by verifying the tax returns. In cases where verification of tax returns is not an option, other forms of verification should be used (e.g., sales taxes paid to a state can be used to verify revenues for a retail business). This is particularly true in the case of business valuations where there is insufficient independent information available (e.g., where a division of a business is being sold). Finally, the source of information (e.g., the lender, a packager, an accountant, the applicant, etc.) must be identified in the lender’s documentation.
Documentation of Effort to Comply with Notice 5000-677
Specific documentation requirements have not been included because of the variety of business types and situations a lender is likely to encounter. A lender’s files should provide evidence of the thought process the lender used to arrive at the decision to make a loan.
Use of the PLP Program Existing procedures related to submission of documents to the PLP Center are not changed by Notice 5000-677 or this Notice. However, financial statement verification (including IRS verification) and appraisal work must be complete before the loan is sent to SBA so that SBA knows that all of the information has been verified before SBA begins processing.
PLP Status Notice 5000-677 mentioned holding lenders to a higher level of due diligence and the possible forfeiture of PLP status. SBA's intent was to convey the seriousness of the situation and inform lenders of the need for additional scrutiny of applications for change of ownership loans. As always, the Agency is willing to work with lenders to serve the needs of the public in a responsible fashion. In some cases, the agency may be required to pursue those who do not act responsibly.
Loans submitted after August 4, 2000 are subject to the requirements of Notice 5000-677 and the modifications contained in this notice.
Reminder The provisions in SOP 50 10 on loan processing continue to apply to all applications.
Questions Questions from lenders and other parties should be directed to the local SBA office. Questions from SBA field staff should be directed to James Hammersley at (202) 205-7505. ____________________________ Hector V. Barreto AdministratorExpires: 12-01-2002
Mid-2008 (Published During Reign of SOP50-10(5))
SBA Standard Operating Procedures (SOP) 50 10 (5), page 179.
Determining the value of a business (not including real estate which is separately valued through an appraisal) is the key component to the analysis of any loan application for a change of ownership. An accurate business valuation is required because the change in ownership will result in new debt unrelated to business operations and create “blue sky” or goodwill. A business valuation assists the lender and the buyer in making the determination that the seller’s asking price issupported by historic operations.
(a) For loans of $350,000 or less, the lender may do its own valuation of the business being sold. (b) For loans greater than $350,000 or if there is a close relationship between the buyer and seller, the lender must obtain an independent business valuation from a qualified source. A “qualified source” is an individual who regularly receives compensation for business valuations and is accredited by a recognized organization. Some recognized organizations and the accreditations they provide include:
Accredited Senior Appraiser (ASA) accredited through the American Society of Appraisers;
Certified Business Appraiser (CBA) accredited through the Institute of Business Appraisers;
Accredited in Business Valuation (ABV) accredited through the American Institute of Certified Public Accountants; and
Certified Valuation Analyst (CVA) accredited through the National Association of Certified Valuation Analysts.
(c) The lender may not use a business valuation provided by the seller or the buyer to meet these requirements. (d) The lender may use a going concern appraisal to meet these requirements if:
the loan proceeds will used to purchase a special use property;
the appraisal is performed by an appraiser experienced in the particular industry; and
the appraisal allocates separate values to the individual components of the transaction including land, building, equipment and the business (“blue sky”).
SBA Standard Operating Procedures (SOP) 50 10 (5), page 179.
Early 2009 (Published During Reign of SOP50-10(5)(A))
TO: All SBA Employees CONTROL NO.: 5000-1096 SUBJECT: SOP 50 10 5(A) policy regarding the financing of goodwill EFFECTIVE: 2/27/2009
Background: SBA Information Notice 5000-1092 issued February 6, 2009, announced the publication of the first update to SOP 50 10(5). The first update to the SOP is known as SOP 50 10 5(A) and will be effective March 1, 2009.
As part of the update, the section on the financing of business acquisitions was modified. Among the changes was new guidance on the amount of goodwill that may be financed with the proceeds of a 7(a) loan. Previously, SOP 50 10(5) stated the following regarding the financing of goodwill:
The lender should explore seller-financing with a subordinate lien to the SBA guaranteed loan on the business assets. The amount of seller-financing that should be considered is the amount being borrowed by the buyer to finance the acquisition of intangible assets such as goodwill.
As the number of 7(a) loans being used for business acquisition has increased, SBA determined that more specific guidance on the financing of goodwill was appropriate and added the following to SOP 50 10 5(A):
Goodwill: (1) If the purchase price of the business includes goodwill (or “blue sky”), the lender should explore seller-financing with a subordinate lien to the SBA-guaranteed loan. (2) The lender may finance a limited amount of goodwill. In no event may the amount of goodwill financed by an SBA guaranteed loan exceed 50% of the loan amount up to a maximum of $250,000. (3) If any of the loan proceeds will be used to finance goodwill, the amount must be specifically identified in the Use of Proceeds section of the Authorization.
We have received comments on this issue from lenders and business brokers. Business brokers have commented that this will have a significant negative impact on their business. They are concerned that many sellers do not want to finance a portion of the sale to the new owner as was recommended in the previous versions of SOP 50 10. The comments from lenders are on both sides of the issue.
Several lenders stated that they do not finance goodwill on a conventional basis. These lenders believe that goodwill is the riskiest asset on a small business borrower’s books and do not believe that an SBA guaranteed loan should used to finance goodwill. Other lenders stated that SBA financing of goodwill is the only financing available in the present credit market and that limiting the amount of goodwill that can be financed using a 7(a) loan to $250,000 will effectively stop business acquisitions. Some lenders suggested that many newly unemployed individuals are considering the purchase of a business and that it is appropriate for SBA, in its role of financing those businesses that cannot access conventional loans, to provide guarantees on loans to these individuals when seller financing is not available.
SBA began collecting data on business acquisitions approximately 4 years ago. But, as SBA did not expressly address the financing of goodwill in the SOP, the data does not include how much of the business acquisition was goodwill or whether the goodwill portion was financed by the seller or by the buyer with non-SBA guaranteed funds. Thus, the initial performance data of these loans is inadequate to draw conclusions on the overall performance of loans with a substantial amount of goodwill.
Because SBA does not have data specifically identifying goodwill in business acquisitions and because the Agency has been told there are limited options for those borrowers wishing to finance a business acquisition involving a substantial amount of goodwill, SBA has decided that it will review loan applications that do not meet the guidance in the SOP.
Option for SBA ReviewFor loan applications where the request for 7(a) financing of goodwill exceeds the limits set in SOP 50 10 5(A) because the buyer and/or the seller are unable to finance the amount of goodwill that exceeds the SOP limit, the lender may submit the application to the Standard 7a Loan Guaranty Processing Center (LGPC) for SBA’s consideration.
The submission must include: 1. a completed Form 4; 2. a completed Form 4-I including the lender’s internal credit memo; 3. a completed Form 159(7a) where required; 4. a detailed explanation as to the circumstances that prevent the seller and/or buyer from meeting the SOP requirements for the financing of the balance of the goodwill; 5. a business valuation as required in SOP 50 10 5(A), Subpart B, Chapter 4, Paragraph II.C. to include the name and address of the individual performing the business valuation; 6. any appraisals used to establish the value of real estate and/or equipment; 7. the name and address of any broker involved in the transaction and the fee charged for their services; and 8. any other information that the LGPC needs to finish processing a specific application.This process will be in place through August 31st, 2009. At that time, SBA will provide further guidance on this issue. During this six month period, SBA will collect information from the applications submitted to the LGPC and analyze the types of businesses and transaction structures submitted.
Definition of Goodwill“Goodwill” is created when an existing business is acquired and the acquiring entity pays more for the business than the book value of the business’s assets. Simply put, “goodwill” is the premium the seller is requiring as part of the purchase price (and the buyer is willing to pay) for an established business in the marketplace as compared to that same buyer starting a new business. By paying a premium for an established business, the buyer is relying on the existing business’s established market share to continue due to such reasons as an established customer base, a premium location, etc. (Customer lists and non-compete agreements are documents that the seller may provide to support the goodwill the seller is requesting.)
For SBA purposes, the amount of goodwill resulting from a change of ownership is determined as follows:
1. Asset purchase: Selling Price minus the sum of the book value of all assets being purchased = goodwill. (If the lender has obtained an appraisal for any real estate or machinery and equipment being acquired, the appraised value may be substituted for the book value for these assets. If the business being sold has intangibles such as licenses or patents on its balance sheet, the book value must be used for these assets. Intangibles that do not have an existing book value may not be subtracted from the selling price.)
2. Stock purchase: Selling Price minus (the sum of the book value of all assets being purchased minus the sum of all liabilities that are being assumed) = goodwill. (If the lender has obtained an appraisal for any real estate or machinery and equipment being acquired, the appraised value may be substituted for the book value for these assets. If the business being sold has intangibles such as licenses or patents on its balance sheet, the book value must be used for these assets. Intangibles that do not have an existing book value may not be subtracted from the selling price.)
Additional Information Lenders and other interested parties may continue to send suggestions concerning the SOP to SBA at SOP50-10Modernization@sba.gov. This e-mail box is set up to receive only. Questions regarding SOP 50 10 5(A) should be directed to the lender relations specialist in the local SBA field office. _________________________ Grady B. HedgespethDirector, Office of Financial Assistance
Late 2009 (Published in September; Prior to 50-10(5)(B))
All SBA Employees
Issuance of SOP 50 10 5(B) – Lender and Development Company Loan Programs
The Office of Financial Assistance is announcing the publication of an update to the Standard Operating Procedure (SOP) 50 10 5. This update to the SOP will be known as SOP 50 10 5(B) and will be effective on October 1, 2009. This version of the SOP will apply to all applications received by SBA on or after October 1, 2009.
As with previous editions of SOP 50 10 5, SBA will post two versions on the web site. The first version will show all changes as “tracked changes” to enable users to more easily identify what has been modified. (As a note, the Table of Contents and all of the hyperlinks have been updated but, for ease of viewing, those changes are not shown.) The second version incorporates all of the changes into the document. The revised SOP may be found at http://www.sba.gov/aboutsba/sbaprograms/elending/reg/index.html
The following is a summary of the key changes made to this version of the SOP:
SBA changed the guidance for financing transactions involving intangible assets:
If a transaction includes $500,000 or less of intangible assets (including, but not limited to, goodwill, client/customer lists, patents, copyrights, trademarks and agreements not to compete), a lender may process the loan using its delegated authority.
If the application includes more than $500,000 of intangible assets and the borrower and/or seller have contributed a total of at least 25% equity, the loan also may be processed using a Lender’s delegated authority. (Seller equity is defined as seller take-back financing that is on full standby (principal and interest) for a minimum of 2 years.)
If the loan amount includes more than $500,000 in intangible assets and the borrower and/or seller are not providing at least 25% equity, then the application must be sent to the Standard 7(a) Loan Guaranty Processing Center in Citrus Heights for review and approval by SBA.
The amount of intangible assets financed with loan proceeds must be specifically identified in the Use of Proceeds section of the application and the loan authorization.
The 504 refinancing authority in the American Recovery and Reinvestment Act was incorporated.
Conforms the guidance on establishing the maximum fixed interest rate more closely to the regulation which states that SBA will periodically publish the maximum allowable fixed rate in the Federal Register. The maximum allowable rate will be based on the LIBOR swap rate, which will permit borrowers to get a fixed rate loan that is based on the cost of a swap contract for a LIBOR-based variable rate loan.
Revised the guidance on post construction certifications to require the appraiser to state that the building was built according to plans and specifications with only minor modifications (if any). An additional change was made to the appraisal guidance for 504 loans to address the situation where the property has declined in value and additional collateral or additional investment is not available. If the applicant demonstrates strong, consistent cash flow sufficient to support the debt, the Sacramento Loan Processing Center can approve the appraisal and the CDC may close the loan.
Clarified the required submission of a State-Chartered Credit Union when it is applying to participate in the Section 7(a) program.
Streamlined the required submission for CLP and PLP applications.
Added a clarification that a Technical Assistance provider agreement used by a Community Express Lender must specifically identify all fees to be charged by the Technical Assistance provider and clarified that a Lender may not pay referral fees to the T/A provider in addition to fees for services provided.
Clarified that any credit card debt that is going to be refinanced must be business related credit card debt and provided guidance on how to document that such credit card debt is business related
Conformed the 20% improvement in cash flow requirement on refinanced debt in the 7(a) program to 10% to match the recently implemented requirement in the 504 program, and clarified that the improvement in cash flow requirement does not apply to certain types of debt allowed to be refinanced (such as long term debt structured with a balloon payment).
Revised the language concerning increases for Standard 7(a), CLP and PLP loans so that the Commercial Loan Servicing Centers can approve requests that are for more than 20% of the loan amount or more than 18 months after loan approval. Previously such requests were approved in headquarters. Also clarified the language surrounding increases in SBA Express and the Pilot Loan Programs.
Clarified that lenders are to follow their existing policy on conventional loans for site visits on their SBA-guaranteed loans.
Conformed to the regulatory requirement that lenders review the character of the operating company as well as the individual owners and clarified that the credit write-up is to include a discussion of any Federal, State, or local citations or probations that would affect the ability of the business to continue operations.
Provided guidance on documenting the lender’s inability to perfect a lien on marketable securities.
Included a description of a new, expedited service for income verification offered by the IRS (from Notice 5000-1087).
Revised the guidance to provide that the CDC determines whether a change of ownership results in a “New Business,” which requires an additional 5% borrower’s contribution.
Clarified that a Section 504 Third Party Lender may close and begin amortizing its loan as long as the 504 project is completed and the business is in operation at the Project location even though the debenture has not yet funded.
Clarified that the CDC’s finding of no adverse change must be made no more than 14 calendar days prior to submission to the Sacramento Loan Processing Center (SLPC).
Enhanced the requirements for documenting the fact that a borrower cannot obtain credit elsewhere.
All policy and procedural notices issued between January 1, 2009 and June 30, 2009 were incorporated into the SOP.
SOP Update Process
The Agency has determined that updating the SOP every six months is no longer necessary. Thus, the next update of SOP 50 10 5 will be published in 12 months.
Lenders, CDCs and other interested parties may continue to send suggestions concerning the SOP to SBA at SOP50-10Modernization@sba.gov. This e-mail box is set up to receive only.
Questions regarding SOP 50 10 5(B) should be directed to the lender relations specialist in the local SBA field office.
Grady B. Hedgespeth
Director, Office of Financial Assistance
Veterans Entrepreneurship and Small Business Development Act of 1999
48 CFR Parts 2, 4, 5, 7, 19, 52, and 53. FAR Amendment implementing the Veterans Entrepreneurship and Small Business Development Act of 1999; Interim rule with request for comments on or before December 11, 2000. [PDF]
PART 121--Small Business Size Regulations
SBA's size standards define whether a business entity is small and, thus, eligible for Government programs and preferences reserved for "small business" concerns. Size standards have been established for types of economic activity, or industry, generally under the North American Industry Classification System (NAICS).
For access to specific sections of CFR 121, go here.
Small Business Information - The U.S. Equal Employment Opportunity Commission (EEOC) enforces the federal laws that prohibit employment discrimination on the basis of an individual's race, color, religion, sex, national origin, age, or disability.