New SBA Rule Raises Barriers for Loans to ESOP Companies

The 2018 Main Street Employee Ownership Act made it much more practical for the SBA to guarantee bank loans under its 7(a) program for companies seeking to borrow money to buy out owners through an ESOP. After the law was passed, the SBA issued standard operating procedures that directly contradicted the law; however, by 2022 these issues were largely resolved, and banks started making loans under the 7(a) program.

On March 1 of this year, however, the SBA issued its Update to SOP 50 10 8 – Citizenship and Residency Requirements and Recission of Procedural Notice 5000-872050. The law requires that no SBA loan or loan guarantee be made to a company with any direct or indirect owners who are non-US citizens. Indirect owners include beneficiaries of an ESOP. The SBA has taken the opposite position regarding standards for its 8(a) set-aside program, widely used by government agencies at all levels to determine whether a company is owned by qualifying historically disadvantaged individuals. For this purpose, the SBA considers only the trust to be the owner and will not qualify a company, even if most of its employees meet the eligibility tests.

The new rule requires that a bank certify that no plan participants are non-US citizens. This would include green card holders. In a letter withdrawing an ESOP company's request for a loan that was shared with the NCEO, the SBA wrote that “Participants in an ESOP are considered Indirect Owners of the Applicant and must be disclosed on the Form 1919 and input in E-tran as Indirect Owners of the Applicant. They must also meet all citizenship eligibility criteria for direct and indirect owners.” Form 1919 is a detailed questionnaire about personal demographics and finances. A bank could make that certification itself, but most banks will not want to take that risk and would want all participants to fill out the form. We have already heard that this has led to a number of potential ESOP loans not being made.