May 11, 2023

SBA Adopts New Guidance Making Loans to ESOPs Much Easier

NCEO founder and senior staff member

The Small Business Administration (SBA) has taken steps to make loans to ESOPs much easier than under prior rules. The agency had received considerable criticism for issuing requirements for ESOP loans inconsistent with the language and intention of the Main Street Employee Ownership Act (MSEOA). That law was passed in 2018 to remove numerous barriers that made SBA loans or loan guarantees for ESOP acquisitions impractical. The law was also designed to allow ESOPs to qualify for loans under the SBA’s 7(a) program, which allows qualified lenders to process loan applications that can receive SBA guarantees. The loans can be for up to $5 million.

The law stipulated that the SBA’s administrator “may” make the changes the law provided, but the regulations SBA initially issued made things harder, not easier. Over the next few years, Representatives Dean Phillips (D-MN) and Nydia Velazquez (D-NY), both on the House Small Business Committee, led an effort to get the SBA to make changes. It appears this effort has finally paid off.

In prior rulings, the SBA had required an equity infusion of at least 10% when an ESOP bought a company. That is an impractical requirement in most ESOP transactions. The SBA eliminated this requirement on May 9 in Procedural Notice 5000-846607 (PDF).

In the new May 9 guidance, the SBA also said that personal loan guarantees in ESOPs will apply only if the ESOP is buying less than a controlling interest, easing some prior ambiguity.

Another barrier was outlined in the SBA’s Affiliation and Lending Criteria for the SBA Business Loan Programs rule (13 CFR 120 and 13 CFR 121, April 10, 2023). There, the SBA continued to insist that ESOP loans be made only by the SBA, a more cumbersome process, not through the 7(a) program.

The SBA announced that it would remove this barrier in its SOP 50 10, Version 7. Starting on August 1, 2023, these loans will be able to go through the 7(a) program.

That same guidance indicates that there does not need to be a separate valuation for the SBA, as has often been required in the past. The guidance language does not specifically address this, but the requirements for the valuation would seemingly be met by a valuation done under ERISA standards. Section 7(a) lenders can make this determination themselves.

A potential barrier remains in the requirement that there be a letter of determination for the loan to be approved, but lenders tell us this has not been a significant problem. The SBA also requires that it be paid off before any subordinated debt, such as a seller note, can start to be repaid, but it may be able to review this requirement after a few years into the loan to allow the note to start being repaid.