SBA Adopts New Guidance Making Loans to ESOPs Much Easier
Updated February 28, 2025
The Small Business Administration (SBA) has taken steps to make loans to ESOPs much easier than under prior rules. The agency had received considerable criticism for issuing requirements for ESOP loans inconsistent with the language and intention of the Main Street Employee Ownership Act (MSEOA). That law was passed in 2018 to remove numerous barriers that made SBA loans or loan guarantees for ESOP acquisitions impractical. The law was also designed to allow ESOPs to qualify for loans under the SBA’s 7(a) program, which allows qualified lenders to process loan applications that can receive SBA guarantees. The loans can be for up to $5 million.
The law stipulated that the SBA’s administrator “may” make the changes the law provided, but the regulations SBA initially issued made things harder, not easier. Over the next few years, Representatives Dean Phillips (D-MN) and Nydia Velazquez (D-NY), both on the House Small Business Committee, led an effort to get the SBA to make changes. It appears this effort has finally paid off.
In prior rulings, the SBA had required an equity infusion of at least 10% when an ESOP bought a company. That is an impractical requirement in most ESOP transactions. The SBA eliminated this requirement on May 9 in Procedural Notice 5000-846607 (PDF).
Another barrier was outlined in the SBA’s Affiliation and Lending Criteria for the SBA Business Loan Programs rule (13 CFR 120 and 13 CFR 121, April 10, 2023). There, the SBA continued to insist that ESOP loans be made only by the SBA, a more cumbersome process, not through the 7(a) program.
The SBA announced that it would remove this barrier in its SOP 50 10, Version 7. Starting on August 1, 2023, these loans will be able to go through the 7(a) program.
In June 2024, the SBA issued procedural guidance (SBA Procedural Notice control no. 5000-858322, June 24, 2024) providing that a valuation done for an ESOP trustee to obtain a fair market value for shares purchased by the ESOP in a leveraged transaction using an SBA loan guarantee under the Main Street Employee Ownership Act of 2018 will satisfy the SBA's requirement for a valuation of the stock. Before this guidance was issued, SBA officers could and often did ask for a separate valuation to be performed following SBA standards. That meant companies would have two different valuations and correspondingly greater costs, and the transaction would take more time. There could also be fiduciary issues if the SBA valuation came in below the valuation for the trustee, while if the valuation came in higher, sellers might be less willing to do the deal.
A potential barrier remains in the requirement that there be a letter of determination for the loan to be approved, but lenders tell us this has not been a significant problem.
As a result of these changes, several banks have become active in making loans under the program as 7(a) lenders. Getting an SBA backed loan generally will not lower the interest rate on the loan, and may even increase it slightly, but it will allow companies to obtain more money at senior debt rates than would otherwise be possible. That usually would mean that the seller notes required in many ESOPs could be smaller.