It is no secret that documenting equity injection for SBA loans can be a painstaking task. In the past, borrowers often utilized home equity lines of credit as their source of injection. However, plummeting home values and SBA rule restrictions implemented in the SOP 50-10(5) have virtually eliminated this source. Accordingly, borrowers are increasingly providing equity injection in the form of qualified rollovers of their existing 401(k), profit sharing plan or other qualified retirement account (collectively referred to herein as QRAs). To document this form of equity injection, lenders must conduct a unique analysis.

Lenders must first be able to identify a QRA rollover. In a rollover scenario, the QRA purchases some percentage of the borrowing entity’s stock. If the QRA owns at least 20% of the borrowing entity, pursuant to SBA regulations, it must provide a guaranty. By definition, QRAs cannot provide guarantees. Since lenders cannot obtain the guaranty of a QRA, the previous SOP required lenders to apply to the SBA’s Associate Administrator for Financial Assistance (AA/FA) for a guaranty waiver. Because an externally imposed legal restriction (ERISA) prevents QRAs from providing guaranties, the AA/FA was able to waive the SBA’s guaranty requirement. When the AA/FA did grant a guaranty waiver, all principals and beneficiaries were required to pledge their personal and unlimited guaranties. Under the SOP 50-10(5), lenders are no longer required to obtain a waiver from the SBA. Nevertheless, lenders still must obtain the same documentation as if they were submitting a waiver request, including securing the unlimited guaranty of all principals and QRA beneficiaries.

There are three scenarios in which lenders are prevented from documenting a guaranty waiver. First, a QRA cannot purchase the stock of an EPC. The AA/FA did not possess the authority to waive guarantees in these instances, and by extension, lenders do not have this authority. Next, a QRA cannot own 100% of the borrowing entity’s stock. ERISA rules state that neither a QRA nor its individual holder is permitted to incur debt, which prevents the beneficiary/principal from providing his or her guaranty. This situation is ineligible because any beneficiary of a QRA must provide his or her personal guaranty when the QRA owns 20% or more of the borrowing entity. Finally, the borrowing entity cannot be an S-corporation. The professionals who establish these QRA rollovers have stated that in order to be eligible, the entities must be C-corporations. Lenders can verify this information with the professional firm that facilitates the rollover.

Provided none of the ineligible scenarios exist, lenders must next confirm that several requirements are met. Most importantly, individual owners must pay for their stock in an amount that is commensurate with their ownership percentage. In other words, the price per share paid by individuals must be equal to the price paid by the QRA for its shares, and the resulting ownership interests must be proportional to the price paid. Lenders should verify these amounts with the professional firm that orchestrates the QRA rollover and confirm that the funds were deposited in the C-corporation’s bank account. Secondly, if an individual’s spouse has any entitlement to the benefits of the QRA, he or she must provide a full unlimited guaranty. Lastly, an individual’s guaranty must be secured if the value of the business assets securing the loan is less than the amount of the loan.

The final piece of documentation lenders must obtain is an opinion letter from ERISA counsel containing the following: (1) a description of the type of retirement account (the Plan) that owns at least 20% of the business; (2) the specific cite under the IRC that describes the type of Plan; (3) the specific cite under IRC that delineates why the Plan cannot take on any liabilities; and (4) a statement of how the Plan got to be or will be “qualified”. If the Plan is already qualified, counsel must provide IRS documentation showing how it achieved qualified status. If the Plan will be qualified in the future, ERISA counsel must provide (1) a statement of when application was made to the IRS for determination of “qualified” classification; (2) a statement that in the counsel’s opinion, the application will comply with the IRC and ERISA regulations; and (3) a statement that upon final determination from IRS, the Plan trustee will provide the lender with a copy of the approval.

The reasoning behind the prior SOP was not simply to assist lenders in documenting the absence of an otherwise required guaranty, but also to insure that the Plan had or would have obtained “qualified” status from the IRS. A proper QRA rollover will not incur early withdrawal penalties. However, if an unqualified retirement account were to purchase the shares of the borrowing entity, it would incur hefty early withdrawal penalties. The IRS would likely assess these penalties against the borrower within the first loan year and potentially cause a loan to default. Because the QRA funds are a portion of the borrower’s equity injection, this early default could jeopardize the SBA guaranty. In conclusion, in order to preserve the SBA guaranty and facilitate the success of their borrowers, lenders must diligently document QRA rollovers.


By: Annie C. Johnson, Esquire

Tags: Associate Administrator, Beneficiaries, Borrowers, Equity Injection, Erisa, Financial Assistance, Guaranty, Home Equity Lines, Home Equity Lines Of Credit, Home Values, Legal Restriction, Painstaking Task, Principals, Profit Sharing Plan, Retirement Plan Rollovers, Sba Lenders, Sba Loans, Sba Regulations, Sop, Waiver Request