Alerts

Jun 30, 2017

What SBA lenders need to know about equity injection

The failure to properly document and verify an equity injection during the loan authorization process is one of the most common reasons for a reduction or denial of an SBA guaranty. SBA lenders can avoid these pitfalls by strictly adhering to the following provisions of the SBA’s Standard Operating Procedures:

Acceptable sources of an equity injection

The following may be considered as an equity injection:

  • Cash that is not borrowed; or
  • Cash that IS borrowed if the small business applicant can demonstrate repayment of this personal loan from sources other than the cash flow of the business, the cash injection may be considered equity. (Note: The salary of the business owner does not qualify.)

A lender must disclose any loan made to an individual for the purpose of providing an equity injection into the business. The lender’s credit analysis must address the impact on the personal and business balance sheets and sources of repayment for such side loans. If the SBA participating lender is providing the personal loan, the lender must submit the application for guaranty through standard 7(a) processing.

Proper documentation of an equity injection

Lenders must verify the injection prior to disbursing loan proceeds and must maintain evidence of such verification in their loan files. Lenders are expected to use reasonable and prudent efforts to verify that equity is injected and used as intended, and failure to do so may warrant a repair or partial/full denial. With each purchase request on a loan for which the loan authorization required an equity injection, lenders must submit documentation to show that they verified the equity injection. Verifying a cash injection requires the following documentation:

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  • A copy of the statements of account for the account from which the funds are being withdrawn for each of the two most recent months prior to disbursement showing that the funds were available; and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

A promissory note, “gift letter” or financial statement is not sufficient evidence of cash injection without corroborating evidence consistent with the foregoing requirements.

It is imperative that SBA lenders understand the servicing rules and guidelines as mandated by the SBA’s Standard Operating Procedures. The best practice for any SBA lender is to approach the management of SBA-related loans as a team effort. Lenders should ensure that SBA experience is not limited to its internal team but that it also extends to any servicer, law firm and/or agent the lender is collaborating with. Due to the complexity and fluidity of the Standard Operating Procedures, the experience of trusted agents is an invaluable asset.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: Sarah K. Lash, Principal