What You Need to Know About the Latest Changes to SBA SOP 50 10
If you’ve been following the Entrepreneurship Through Acquisition (ETA) community at all recently, you know that last week the Small Business Administration (SBA) issued major updates to Standard Operating Procedure (SOP) 50 10.
Standard Operating Procedure 50 10 governs SBA 7(a) and 504 loan eligibility requirements. And given the central role that 7(a) loans, in particular, play in U.S. small business acquisitions, understanding these updates is crucial.
So let’s look at the key changes and surmise how they could impact dealmaking.
But first…
What is a Standard Operating Procedure?
That’s a fair question, especially if you’re new to the search.
SOPs are the rulebooks that govern SBA loan programs. SOP 50 10 is one such rulebook. But there are others. For example, SOP 50 57 relates to 7(a) loan servicing and liquidation requirements.
All SBA lenders have to follow the SOPs. To the extent lenders have discretion when issuing and servicing SBA loans, it is within the confines of the SOP framework.
The latest version of SOP 50 10 is version 8. It goes into effect on June 1, 2025.
SOP 50 10 8: Key Changes to the SBA 7(a) Loan Program
Standard Operating Procedure 50 10 8 represents a significant change to 7(a) loan eligibility requirements.
To give you a feel for the magnitude of this change, page 2 of SOP 50 10 8 reads “Key Pages Affected in this Version: All.” (emphasis added).
Yet from the buyer’s perspective, the most important updates can be distilled into two categories. Those impacting:
Partial changes of ownership
Equity injections vis-à-vis seller financing.
(Since this article was written, the SBA has made a further change to SOP 50 10 8. Read this LinkedIn post for more information.)
1. Partial Changes of Ownership
Let’s not mince words: As a result of SOP 50 10 8, partial changes of ownership are all but dead.
As a reminder, partial changes of ownership are those transactions in which the seller ends up with an ownership stake in the target company post close.
In the context of SMB M&A, they take two forms: (A) traditional rollovers; and (B) retained equity (confusingly, some people also refer to this as rollover equity).
A. Traditional Rollovers
In a traditional rollover, the buyer forms a new company to purchase all or substantially all of the assets of the target company. The seller then rolls a percentage of the purchase price into the new company via a tax deferred contribution and receives equity in the new company in return.
The SBA has a special name for traditional rollovers: Multi-step partial changes of ownership.
And, as clearly stated in Section B, Chapter 1.A.2. of SOP 50 10 8, multi-step partial changes of ownership will no longer be allowed.
I’ve written about rollovers before. For those interested, you can still read that post here. But for now, this valuable structuring tool is going away.
Some of you may be asking: Weren’t rollovers a relatively recent SBA innovation?
Yes. It was only last year that the SBA gave rollovers the thumbs up.
What can I say? Elections have consequences.
B. Retained Equity
Retained equity is similar to rollover equity. In fact, the terms are often used interchangeably within the ETA community.
Yet with retained equity, the buyer is purchasing less than 100% of the target company’s equity, with the seller retaining an ownership stake post-close. For example, the buyer may purchase 90%, leaving the seller with 10%.
The SBA refers to this structure simply as a partial change of ownership. And come June 1, this structure will still be allowed… in theory.
In theory?
Yes, in theory. Because in practice, the SBA will erect two sizable barriers to partial changes of ownership.
First, any person who gains a direct or indirect ownership interest in the target company (i.e., any person who benefits from the loan proceeds), must be a co-borrower (see Section B. Chapter 1.A.2.h.i of SOP 50 10 8).
This change is huge. It’s broadly worded and captures all kinds of stakeholders. This includes minority investors, no matter how small their investment and regardless of how they choose to invest.
To be clear, co-borrowers are personally on the hook for the SBA loan. And since it is unlikely that any investor will want to take on that liability, partial changes of ownership involving investor equity are almost certainly dead.
But that’s not all.
Second, any seller (i.e., an owner who receives loan proceeds) who retains equity in the target company post-close must provide a full loan guaranty for a period of at least two years (see Section B. Chapter 1.A.2.h.iv.a of SOP 50 10 8).
Again, this change is huge. Currently, only owners who hold 20% or more of the company’s equity post close have to guarantee the loan (for the full term, which is usually 10 years).
This existing rule will stay in effect.
But in addition, any seller who retains less than 20% will also have to guarantee the loan for at least two years. And as with investors, a seller is unlikely to want to take on that liability.
There are many reasons why the buyer (and even the lender) may want the seller to retain equity in the target company. I’ve written about it before. You can read that post here.
But come June 1, it may not matter.
Partial changes of ownership are all but dead.
Thank you SOP 50 10 8.
2. Equity Injections vis-à-vis Seller Financing.
SBA loans require a buyer equity injection. In general, this must be at least 10 percent of the total project costs (purchase price plus transaction expenses plus working capital).
Currently, a seller’s note can count towards the equity injection if, for the first 24 months, it is on:
Full standby (no payments whatsoever); or
Partial standby (interest payments only), but only under certain conditions.
As a reminder, a seller note is simply a loan the seller makes to the buyer. They align incentives between buyers and sellers, and are a core component of ETA dealmaking.
But as of June 1, a seller’s note will only count towards the buyer’s equity injection if it is on full standby for the full term of the SBA loan.
Will sellers agree to forgo all payments for ten years? Will they agree to simply hold the debt (while interest accrues).
It will depend on whether other buyers can do the deal without making that request.
It will also depend on the seller. The iconic ETA seller, the silver-haired retiree? Maybe not. Maybe she wants her money sooner than that.
The bottom line is this: If you are looking to purchase, say, a $3,000,000 business, you now need to find $300,000. And if you don’t have that much capital to hand, you may have to raise it.
Meeting the SBA’s equity injection requirements just got a lot harder.
Action Steps for Business Buyers
Are you staring at a signed Letter of Intent wondering what to do about these changes?
You have three options:
1. Move Quickly
You don’t need to close by May 31; you need to secure an SBA loan number by May 31.
What does it take to secure an SBA loan number? The specifics depend on the lender. But in general, you will need:
The lender to have finished underwriting (with deal approval)
A near-final purchase agreement
A final capital table.
You may also need to have ticked off other items on your lender’s checklist, including obtaining business insurance, a landlord waiver, etc.
The window to obtain an SBA loan number is fast closing.
2. Restructure
If you don’t have enough time to close, you will have to restructure.
You may have options:
A. Is There Another Minority Owner?
There are some deals that are hard to do unless there is a partial change of ownership. I’m thinking about licensed companies, like HVAC businesses in those states where the license holder also has to be an owner.
In these deals, the seller often retains a small equity stake in the business post close until the buyer can obtain the required license.
Yet if the seller is the only license holder, you may be in trouble. You’ll run into the requirement that the seller has to guarantee the SBA loan for two years. And this, the seller may not want to do.
But if there is a second minority owner who also holds a license, you may be able to proceed with the partial change of ownership as planned if that minority owner agrees to retain her ownership interest.
Remember, only the selling owner (i.e., one who receives loan proceeds) will have to guarantee the loan. An owner who simply carries over a 10% interest will not have that obligation.
B. Can You Switch From a Partial Change of Ownership to a Complete Change of Ownership?
Your ability to do so will depend on why you want the seller to retain equity. If it is simply to bridge a valuation gap (between the maximum obtainable loan amount and the purchase price), you can restructure the purchase price offer.
For example, you could ask the seller to agree to a larger seller note.
Of course, if you want the seller to retain equity for a different reason (e.g., the licensing issue discussed above), this might not be an option.
C. Struggling to Find the Equity Injection? Try Using Two Seller Notes.
The first note can be on full standby for 10 years, thereby adhering to the new requirements for equity injections. The second note can be free from standby or be on standby for a lessor amount of time.
That way, the seller isn’t holding the full seller note on standby for 10 years.
If the seller is resistant to the idea, try sweetening the offer by offering an above-market rate of interest (turning the note into a more valuable investment).
3. Wait
Wait?
That doesn’t sound like a good strategy. But hear me out.
I have spoken with a number of lenders who seem to believe that the SBA will make further changes to SOP 50 10 8 before the June 1 effective date.
Specifically, the SBA may revise SOP 50 10 8 to clarify that minority investors (those holding less than 20% of the target company’s equity post close) in deals involving partial changes of ownership will not have to sign the SBA loan as a co-borrower.
If you don’t have time to secure an SBA loan number by May 31. If restructuring isn’t possible. If your deal could move forward if it weren’t for this issue.
Try waiting.
It can’t hurt. And you don’t have many other options.