Final Rule Affiliation and Lending Criteria: Changes to the SBA Business Loan Programs in 2023

The SBA’s latest rule, published April 10, 2023, will have a material impact on SBA lenders of all sizes. This high-level overview notes key takeaways from the Final Rule before becoming effective May 11, 2023. Key Takeaways from the most recent May 2023 Procedural Notices are outlined here.

The changes enacted by the Final Rule (published April 10^th) will have substantial impacts on the SBA lending process for lenders of all sizes. These changes are expected to be reflected in the next iteration of SOP 50 10, through which we expect to receive further clarification and guidance.

While we cannot yet determine when the next iteration of SOP 50 10 will be released, or specific scenarios related to the rules changes at this time, the following are key changes to note as we await supplementary information.

Key Takeaways of Final Rule SBA Changes in 2023 to:

• Uses of Proceeds
• Lending Criteria
• Loan Conditions
• Reconsideration After Denial
• Small Business Size Standards and Affiliation
• (Anticipated) Updated SOP

SBA Use of Proceeds: Partial Business Acquisitions are Now Allowed

SBA will now allow loan proceeds to be used for partial business acquisitions.

The Final Rule also clarified that the selling owner is allowed to “remain as an owner and involved in the day-to-day business, including as an officer, director, Key Employee, or employee”.

Additionally, the SBA revised regulations to make payments to “facilitate changes of ownership” exempt from the prohibition on using loan proceeds to pay an associate of the business applicant.

SBA Lending Criteria Changes in 2023: Opportunity for Lender-Determined Credit Policies

The SBA will now require lenders to determine their own policies for creditworthiness within the scope of their designated credit factors.

Creditworthiness to be Determined by Lender’s Credit Policies for Similarly Sized Commercial Loans

As a substitute for specific factors, SBA has added new language requiring lenders and CDCs to “use appropriate and prudent generally acceptable commercial credit analysis process and procedures consistent with those used for their similarly-sized non-SBA guaranteed commercial loans”.

SBA added language stating that the following credit factors, as applicable, may be considered by lenders, CDCs and the SBA when approving loans.

• Credit score or credit history of the applicant (and the Operating Company, if applicable), its Associates and any guarantors;
• The earnings or cashflow of applicant; or
• Equity or collateral of the applicant, where applicable.

Supplementary information states that lenders and CDCs that do not make non-SBA guaranteed commercial loans will continue to underwrite their SBA loans in accordance with credit policies, including credit scoring models, approved by the SBA as part of their initial approval for SBA participation.

Business Credit Scoring Models to Replace Underwriting for Loans of Certain Sizes (To Be Determined)

Additionally, the SBA added language allowing lenders to use business credit scoring models in lieu of traditional underwriting for some loans.

Supplementary information states that SBA will provide guidance regarding the maximum loan amounts that may use credit scoring models for underwriting, and what additional credit factors must be addressed in addition to documenting a satisfactory credit score.

SBA Lending Criteria to No Longer Include Character Determination

Historically lenders and CDCs had to consider the following factors to determine if the business applicant was creditworthy.

• Character, reputation, and credit history of the applicant (and the Operating Company, if applicable), its Associates, and guarantors;
• Experience and depth of management;
• Strength of the business;
• Past earnings, projected cash flow, and future prospects;
• Ability to repay the loan with earnings from the business;
• Sufficient invested equity to operate on a sound financial basis;
• Potential for long-term success;
• Nature and value of collateral (although inadequate collateral will not be the sole reason for denial of a loan request); and
• The effect of any affiliates may have on the ultimate repayment ability of the applicant.

Character determination will no longer be required since character and reputation are no longer factors for determining creditworthiness.

SBA Loan Conditions: Updated Insurance Requirements for Sub-$500,000 Loans

Hazard insurance for real estate and business personal property collateral will only be required for loans over $500,000.

Supplementary information states that lenders must follow hazard insurance policies for similarly sized non-SBA guaranteed loans.

Borrowers must still obtain flood insurance for loans less than or equal to $500,000 when required under the Flood Disaster Protection Act of 1973.

SBA Loan Reconsideration After Denial: New Determining Authority

The Final Rule revised regulations to allow final reconsiderations for loan denials or loan modification requests to be made by a designee of the Director of the Office of Financial Assistance. The SBA also added new language allowing the SBA Administrator to make the final Agency decision.

SBA Size Standards and Affiliation Principles Includes Removal of the SBA Franchise Directory

The updated small business size standards affiliation principles changed in the 2023 Final Rule are particularly noteworthy for lenders financing franchises and businesses with multiple parties of interest.

SBA Size Standards Defined

According to the new paragraph included in the Final Rule, the SBA now defines a small business as:

“… one which is independently owned and operated, and which is not dominant in its field of operation.  SBA interprets this statutory definition to require, in certain circumstances, the inclusion of other entities (“Affiliates”) owned by the applicant or an owner of the applicant in determining the size of the applicant”.

Affiliation Principle of Control and Franchise Affiliations Removed

The SBA has specifically removed the principle of control of one entity over another as a separate basis for finding affiliation.

Because the principle of control is being removed, SBA is revising “stock options, convertible securities, and agreements to merge” to have an impact on affiliation only if they have a present effect on ownership of the entity.

Affiliation based on franchise and license agreements is also being removed since the principle of control is being removed.  Because of this, the SBA will no longer publish the SBA Franchise Directory and the SBA Franchise Agreement Addendum will not be required.

Affiliation will now be based on ownership and the industry in which the businesses operate. 

The new considerations for determining affiliation are:

• Businesses in which the applicant is a majority owner are affiliates of the applicant;
• Businesses that own a majority of the applicant;
• Businesses in the same three-digit NAICS subsector that are majority-owned by the applicant’s owner;
• Business where the applicant and the other business are both majority-owned by the same individual and operate in the same three-digit NAICS subsector;
• 20% threshold of ownership for affiliation with the applicant when the applicant does not have a majority owner if a 20% owner also operates in the same three-digit NAICS subsector as the applicant;
• If the applicant does not have a majority owner and an individual owns 20% or more of the applicant, businesses that are majority-owned by that owner and operate in the same three-digit NAICS subsector will be affiliates of the applicant;
• Ownership interests of spouses and minor children will be combined when determining ownership interest; and
• SBA will analyze the pro-rata ownership of entities to determine affiliation.

The Anticipated New SOP 50 10: Preparing for Further Guidance in 2023

The changes proposed in the Final Rule are expected to be reflected in the next iteration of SOP 50 10 at an undisclosed date. Some of the updates open further discussions for lenders as they plan to adjust and prepare for the future of SBA lending.

Our team expects further clarification and guidance on these changes from the SOP when available.

As we analyze the potential impacts of the Final Rule on the SBA lending process, and any supplementary information made available, we will continue to update our clients directly with relevant resources in addition to the insights distributed through the Windsor Advantage Newsletter.

Our goal is to equip your department with the most up-to-date insights possible as you continue shaping an effective SBA strategy.