By Steve Mariani, EasySBA.com / Diamond Financial
Each year a large percentage of the SBA-guaranteed loans that we finance includes one or more silent or “angel” investors. Sometimes it’s a family member, other times not. These investors are typically willing to help the business owner with the required down payment, but always prefer to limit their risk. They’re not looking to put their net worth on the line to guarantee an SBA loan for someone else!
I get it, and so does the SBA.
The real criteria that SBA demands all lenders explore are below, which are included in the actual SOP’s. (I always like to begin by referring to the actual SBA rules as written before describing how our firm addresses these investor scenarios!)
Page 191: When deemed necessary for credit or other reasons, SBA or, for a loan processed on a delegated basis, the Lender, may require other appropriate individuals to provide full or limited guaranties of the loan without regard to the percentage of their ownership interests, if any. For example, an individual with a minority ownership or no ownership interest in the Applicant or OC who is critical to the operation of the business may be required to provide a personal guaranty.
Page 325: For example, an individual with a minority ownership or no ownership interest in the Applicant or OC who is critical to the operation of the business may be required to provide a personal guaranty (13 CFR § 120.160(a)).
As you can see, these above rules allow a lender to demand a full guaranty from any person they believe to be “critical to the operation of the business”. This could include operational mangers, key employees, silent investors or anyone the lender deems to be critical or involved in the business at an influential level.
In practice, its important to limit the lender’s reach and exclude anyone.
To do that, first understand that the SBA requires a full guaranty from every owner (or husband and wife combination) owning 20% or more of the new entity. So we know that any investor MUST remain under this threshold if we have any chance of protecting their personal guarantee and personal assets.
There are actual 2 ways that we suggest a silent investor can inject funds into a project.
- GIFTING. The first method is for the “investor” to make the funds a true gift, accompanied by a notarized letter from the giver stating this is a gift and no repayment is ever required. This option is effective when a mom and dad want to assist a son or daughter in purchasing a business. Gifting makes the most sense when the monies being gifted are coming from a close family member. Of course, what friend actual gifts you a few hundred thousand dollars to buy a business? Lenders do and will consider this question when reviewing the injection.
- MINORITY EQUITY: A better method is to the investor minority ownership in the new entity. The investor must be a “minority partner” under the 20% threshold mentioned above to avoid a personal guaranty. The benefit of making the investor a minority owner is clear: With any amount of ownership, the investor is permitted to inject up to 100% of the down payment!
To bring in an investor as a minority owner, we must document this investor’s intentions and involvement in the new entity, if any. When we submit the loan application, we must show that they will not be directly involved in the business in any way and that they are truly a “silent” partner.
This rule is important to understand as it is subject to the interpretation of the lender and many read it differently. I know of more than one lender that demands any person injecting any funds into the project also fully guaranty the loan no matter what amount of ownership or involvement they might have. Lenders are permitted to demand this and add any additional underwriting criteria they deem necessary to secure an internal approval as long as the minimum SBA rules are followed.
Remember that every loan application is a negotiation. At Diamond Financial, we do not allow our lending sources to exceed the actual SBA written rules. We also educate each and every buyer at each level to be sure we utilize the rules most appropriate to their direct structure.
In the end, we are grateful for investors as they help more transactions to happen and we want to be sure we keep them protected. So if you have buyers with great credit and direct industry experience but less money than required, let them find an investor and we’ll keep everyone protected.
For more specific answers on these or any other SBA rules, please contact us at [email protected] — a no cost, no obligation email solution to answer all of your SBA questions. Diamond Financial specializes in larger, goodwill type transactions and we are always happy to share the information that makes them happen.
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Steve Mariani is the Owner of Easysba.com, part of Diamond Financial Services. Diamond has been serving the business brokerage industry since 1996.