Planning for the Unplanned:

SBA’s 504 Loan Requirements for Succession Plans and Life Insurance

A comprehensive succession plan or appropriate life insurance is essential for a small business led by a sole operating individual. This long-term planning ensures stability and continuity during leadership transitions. SBA lenders should evaluate whether a business’s long-term viability is linked to the owner-operator who is guaranteeing an SBA loan.

A succession plan or life insurance is necessary for sole proprietorships or single-member LLCs where the owner’s participation is critical, especially if the SBA loan isn't fully collateralized. If the lenders determine that business viability isn’t tied to the individual owner, this should be well-documented in the credit memo and application package submitted to the SBA.

Succession Plans

A succession plan prepares a business for continued operation after an owner leaves, retires, or becomes disabled. It highlights how the business will maintain stability during key management and company-control transitions.

What are the key elements of a Succession Plan:

• Identification of Successors: Define who will assume key roles, such as family members, current employees, or external candidates.
•  Timeline for Transition: Establish a timeline with milestones for training and the handover of duties.
•  Financial Considerations: Address financing for the ownership transition, including buyout agreements and necessary financial resources.
• Legal Aspects: To minimize disputes, incorporate legal documents like wills and buy-sell agreements.
• Contingency Planning: Prepare for unexpected events, such as illness or sudden departures of the owner.

Life Insurance

Why are life insurance policies important?

• Loan Repayment Assurance: This serves as collateral; insurance payouts can cover the remaining loan balances upon the borrower’s death.
• Business Continuity: Ensures smooth operations during transitions, providing financial stability after a key person's loss.
• Protection for Heirs and Co-Owners: Prevents heirs or partners from being burdened by remaining loans, facilitating easier ownership transfer.

What are typical Life Insurance requirements?

• Minimum Term:
  • 10 years for a 10-year debenture
  • 20 years for a 20- or 25-year debenture
• Collateral Calculations:
  • For SBA 504, the amount of insurance is based on the difference between the net debenture amount (the SBA 504 2nd lien note) and the discounted market value of the collateral (real estate and/or equipment).
•  Collateral Discounts:
  • Improved real estate valued at 85% of fair market value
  • New equipment valued at 75% of price
  • Used equipment valued at no more than 50% of Net Book Value or 80% of Orderly Liquidation Appraisal.
• If a principal is uninsurable, the lender needs documentation from a licensed insurance company.
• The lenders may accept existing life insurance policies but should not require credit or whole life insurance.

When you partner with Community Business Finance, our experience, efficiency, and lending relationships will help you create a success story for your business. Let’s get started today!