Affiliation and Lending Criteria for the SBA Business Loan Programs, 21074-21086 [2023-07173]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 88, Number 68 (Monday, April 10, 2023)]
[Rules and Regulations]
[Pages 21074-21086]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-07173]


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SMALL BUSINESS ADMINISTRATION

13 CFR Parts 120 and 121

RIN 3245-AH87


Affiliation and Lending Criteria for the SBA Business Loan 
Programs

AGENCY: U.S. Small Business Administration.

ACTION: Final rule.

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SUMMARY: The U.S. Small Business Administration (SBA or Agency) is 
amending various regulations governing SBA's 7(a) Loan Program and 504 
Loan Program, including regulations on use of proceeds for partial 
changes of ownership, lending criteria, loan conditions, 
reconsiderations, and affiliation standards, to expand access to 
capital to small businesses and drive economic recovery. The amendments 
to affiliation standards will also apply to the Microloan Program, 
Intermediary Lending Pilot Program, Surety Bond Guarantee Program, and 
the Disaster Loan programs (except for the COVID Economic Injury 
Disaster Loan (EIDL) Disaster Loan Program).

DATES: This rule is effective May 11, 2023.

FOR FURTHER INFORMATION CONTACT: Dianna Seaborn, Director, Office of 
Financial Assistance, Office of Capital Access, Small Business 
Administration, at (202) 205-3645 or [email protected]. The phone 
number above may also be reached by individuals who are deaf or hard of 
hearing, or who have speech disabilities, through the Federal 
Communications Commission's TTY-Based Telecommunications Relay Service 
teletype service at 711.

SUPPLEMENTARY INFORMATION: 

I. Background Information

    The mission of SBA is to ``aid, counsel, assist and protect the 
interests of small business concerns in order to preserve free 
competitive enterprise and to maintain and strengthen the overall 
economy of our nation.'' 15 U.S.C. 631(a). SBA accomplishes this 
mission, in part, through Capital Access programs that bridge the 
financing gap in the private market to help small businesses start and 
grow; and help businesses of all sizes to recover from disasters. 15 
U.S.C. 636(a) and (b). SBA determined that changing conditions in the 
American economy, technological developments, and a constantly evolving 
small business community necessitate the need to revise regulations to 
improve program efficiency and the customer experience for the 7(a) and 
504 Loan Programs. Additionally, SBA determined that revisions for 
similar purposes to SBA regulations on affiliation determinations 
should also apply to the Microloan Program, the Intermediary Lending 
Pilot Program (ILP Program), the Surety Bond Guarantee Program (SBG 
Program), and the Business Disaster Loan Programs, which consist of 
Physical Disaster Business Loans, Economic Injury Disaster Loans 
(EIDL), and Military Reservist Economic Injury Disaster Loans (MREIDL) 
(but do not include COVID EIDL Disaster Loans).
    Accordingly, on October 26, 2022, SBA published a notice of 
proposed rulemaking with a request for comments in the Federal Register 
(87 FR 64724) to streamline and modernize the 7(a) and 504 Loan Program 
regulations setting forth use of proceeds regarding partial changes of 
ownership, lending criteria, hazard insurance requirements, and 
reconsiderations. Specifically, SBA is amending 13 CFR 120.130 on 
``Restrictions on uses of proceeds''; 13 CFR 120.150 on ``What are 
SBA's lending criteria?''; 13 CFR 120.160 on ``Loan conditions''; 13 
CFR 120.193 on ``Reconsideration after denial''; 13 CFR

[[Page 21075]]

120.202 on ``Restrictions on loans for changes of ownership''.
    Regarding 13 CFR 120.130 on ``Restrictions on uses of proceeds'' 
and 13 CFR 120.202 ``Restrictions on loans for changes of ownership'' 
except for where an employee stock ownership plan or Qualified Employee 
Trust (ESOP) purchases a controlling interest (51 percent or more) in 
the employer small business from the current owner(s), SBA's current 
regulations do not permit 7(a) loan proceeds to be used for partial 
changes of ownership. Therefore, SBA is amending restrictions on 
borrowers using 7(a) loan proceeds to effect partial changes of 
ownership to assist small businesses and to expand pathways to 
ownership.
    Regarding 13 CFR 120.150 on ``What are SBA's lending criteria?'' 
SBA stated that streamlining and modernizing regulations on lending 
criteria and loan conditions for its 7(a) and 504 Loan Programs can 
better position the Agency and participating lenders to meet the needs 
of America's small businesses, create jobs, assist with recovery from 
the COVID-19 pandemic, and grow the economy, fueling American 
entrepreneurship. SBA is amending this section to provide capital in 
the form of 7(a) and 504 loans to more small businesses.
    Regarding 13 CFR 120.193 on ``Reconsideration after denial'' SBA is 
amending the process for reconsideration after denial of a loan 
application or loan modification request in its 7(a) and 504 Loan 
Programs to provide the Director, Office of Financial Assistance, with 
the authority to delegate decision making to designees. SBA is also 
amending the regulation to allow the Administrator, solely within their 
discretion, to review these matters and make the final agency decision 
on reconsideration. Such discretionary authority of the Administrator 
would not create additional rights of appeal on the part of an 
applicant not otherwise specified in SBA regulations.
    Further, SBA is simplifying 13 CFR 121.301, which sets forth the 
principles for determining affiliation in the 7(a) Loan Program, 504 
Loan Program, Microloan Program, ILP Program, SBG Program, and Business 
Disaster Loan Programs (except for the COVID EIDL Disaster Loan 
Program). Specifically, SBA is removing the provisions on affiliation 
arising from management and control, franchise or license agreements, 
and identity of interest and to streamline affiliation determinations 
based on ownership. SBA is streamlining the provisions on affiliation 
to remove paragraph (f)(5), affiliation based on franchise and license 
agreements. Because SBA is removing the principle of control of one 
entity over another from its affiliation consideration, this paragraph 
is no longer needed. Upon the effective date of this rule, SBA will no 
longer publish the SBA Franchise Directory. This final rule redefines 
affiliation for all these programs, thereby simplifying affiliation 
determinations.

II. Summary of Comments

    SBA received 146 comments on the proposed rule. Of these, 51 
comments were from lenders, 21 were from cooperatives, 19 were from 
individuals who were making personal comments, 13 were from nonprofit 
organizations that were not lenders or trade groups, 11 were from trade 
groups, eight were from individuals supporting a trade group or other 
entity's comments, and 23 were anonymous or did not indicate an 
organization type.
    SBA received a total of 14 comments from six trade groups, six 
lenders or employees of lenders, and two comments from individuals or 
businesses objecting to the confluence of the proposed changes in the 
notice of proposed rulemaking in the Federal Register (87 FR 64724 
October 26, 2022) to streamline and modernize the 7(a) and 504 Loan 
Program regulations, the notice of proposed rulemaking published in the 
Federal Register (87 FR 66964 November 7, 2022) to lift the moratorium 
on licensing new Small Business Lending Companies (SBLCs), to add a new 
type of entity called a Mission-Based SBLC, and to remove the 
requirement for a Loan Authorization (SBLC Proposed Rule), and SBA's 
announcement of an upcoming revision to the Standard Operating 
Procedures (SOP) 50 10, Lender and Development Company Loan Programs. 
The comments stated the confluence of these revisions are problematic 
as proposed because SBA would immediately invite additional non-
federally regulated entities to participate as 7(a) Lenders without 
first testing whether the streamlining of provisions such as lending 
criteria and hazard insurance will have an adverse effect on SBA's loan 
portfolio. One trade group requested the Administrator to temporarily 
withdraw both proposed rules.
    SBA received 54 comments requesting changes to SBA's regulations 
and procedures for loans to ESOPs and cooperatives. Many of these 
comments were based on a template letter that stated for loans to 
cooperatives, SBA should remove SBA's regulation at Sec.  120.160, 
paragraph (a), which requires personal guarantees from holders of at 
least 20 percent ownership interest in the small business concern that 
receives SBA funding. SBA requires a personal guaranty from owners of 
20 percent or more of the borrower as a prudent and reasonable risk 
mitigation measure. SBA applies the requirements for personal 
guarantees at Sec.  120.160 to all SBA business loans unless otherwise 
prohibited by law. Because the Internal Revenue Service (IRS) prohibits 
ESOPs from guarantying a loan, SBA does not require ESOPs to provide 
guarantees for SBA loans. There is no legal prohibition on requiring a 
guaranty of repayment from a business organized as a cooperative. 
Further, eliminating the requirement for a guaranty of repayment for 
loans to cooperatives would unfairly transfer the burden of the 
increased risk from these loans to the rest of the SBA portfolio. 
Comments also requested that SBA eliminate the requirement for sellers 
to guaranty a loan made to a cooperative that is buying a business from 
the seller. The only time SBA requires a seller to provide a repayment 
guaranty is in a change of ownership when the seller will retain an 
ownership interest in the business after the sale. Under SBA's current 
rules, it is only possible for a seller to retain ownership in a 
business after a change of ownership when the purchaser is an ESOP or 
equivalent trust. SBA requires a personal guaranty from a seller that 
retains an ownership interest in the business after a change of 
ownership to prevent unjust enrichment to the selling owner such as 
when the selling owner personally benefits from the SBA loan proceeds 
and retains ownership in the business without providing any repayment 
guaranty on the loan. Changes to the personal guaranty requirements at 
120.160 advanced by these comments are outside the scope of the changes 
in the proposed rule and will not be addressed in this final rule. 
Comments also requested that SBA reduce equity or equity injection 
requirements for loans to ESOPs and cooperatives. The proposed 
revisions to the equity requirements in Sec.  120.150, ``What are SBA's 
lending criteria?'' are sufficient to provide SBA and lenders with the 
flexibility to underwrite loans to ESOPs and cooperatives in a 
reasonable and prudent manner, including determining what equity or 
equity injection requirements should be placed on a loan for risk 
mitigation. SBA will provide further guidance in its Loan Program 
Requirements.
    SBA has addressed in detail the comments received on specific 
proposed regulatory changes within the section-by-section analysis 
below.

[[Page 21076]]

III. Section-by-Section Analysis

Section 120.130--Restrictions on Uses of Proceeds

    Current Sec.  120.130 details restrictions on uses of loan 
proceeds. Paragraph (g) refers to Sec.  120.202 regarding restrictions 
on borrowers from using loan proceeds to purchase a portion of a 
business or another owner's interest in a business. Because SBA is 
revising Sec.  120.202, as described below, to allow 7(a) loan proceeds 
to fund partial changes of ownership, SBA is also revising Sec.  
120.130, paragraph (g), to remove the reference to section 120.202 so 
that 7(a) loan proceeds may be used for partial changes of ownership. 
Because the revisions to Sec.  120.130 are being made to support the 
revisions at Sec.  120.202 that will allow partial changes of 
ownership, the comments on this section are discussed below in the 
section-by-section analysis for Sec.  120.202.
    Several comments stated that Sec.  120.130(a) currently prohibits 
payments, distributions, or loans to associates (as defined in Sec.  
120.10) of the applicant (except for ordinary compensation for services 
rendered), and this paragraph would also need to be modified to permit 
payments, distributions, or loans to associates of the applicant to 
facilitate partial changes of ownership. SBA had already addressed the 
prohibition in Sec.  120.130(a) that prohibits payments, distributions, 
or loans to associates of the applicant by the proposed revision to 
Sec.  120.202, which, as proposed, would state: ``Notwithstanding Sec.  
120.130(a), a borrower may use 7(a) loan proceeds to purchase a portion 
of or the entirety of an owner's interest in a business, or a partial 
or full purchase of a business itself.'' However, the comments infer 
that there would be some confusion in interpreting the proposed 
revisions to Sec. Sec.  120.130 and 120.202 regarding restrictions on 
uses of proceeds for partial changes of ownership. Accordingly, SBA is 
revising Sec.  120.130, paragraph (a) for clarity to state that 
payments, distributions, or loans to associates of the applicant are 
restricted except for ordinary compensation for services rendered or to 
facilitate changes of ownership in accordance with Sec.  120.202. SBA 
is revising Sec.  120.202 as stated below. SBA is also revising Sec.  
120.130(g) to remove the reference to section 120.202 to permit partial 
changes of ownership to assist small businesses and provide a path of 
ownership for employees.

Section 120.150--What are SBA's lending criteria?

    Current Sec.  120.150 states that SBA's lending criteria for 7(a) 
and 504 loans requires that the applicant (including the Operating 
Company) must be creditworthy; loans must be so sound as to reasonably 
assure repayment; and SBA will consider nine specific factors in its 
lending criteria. The factors consist of: (a) Character, reputation, 
and credit history of the applicant (and the Operating Company, if 
applicable), its associates, and guarantors; (b) Experience and depth 
of management; (c) Strength of the business; (d) Past earnings, 
projected cash flow, and future prospects; (e) Ability to repay the 
loan with earnings from the business; (f) Sufficient invested equity to 
operate on a sound financial basis; (g) Potential for long-term 
success; (h) Nature and value of collateral (although inadequate 
collateral will not be the sole reason for denial of a loan request); 
and (i) The effect any affiliates (as defined in part 121 of this 
chapter) may have on the ultimate repayment ability of the applicant. 
SBA is revising this regulation as discussed below. In revising Sec.  
120.150, SBA retains the requirement that the applicant (including an 
Operating Company) must be creditworthy and that loans must be so sound 
as to reasonably assure repayment, consistent with section 7(a)(6) of 
the Small Business Act.
    SBA is streamlining its lending criteria by reducing the number of 
factors that are required to be applied in determining creditworthiness 
and reasonable assurance of repayment. SBA is revising this section to 
state that, as part of considering whether the applicant (including an 
Operating Company) is creditworthy and the loan is so sound as to 
reasonably assure repayment, SBA, Lenders (as defined in Sec.  120.10), 
and Certified Development Companies (CDC) may consider (as applicable) 
any of the three specific criteria individually or any combination of 
the three specific criteria when approving loans: (a) The credit score 
or credit history of the applicant (and the Operating Company, if 
applicable), its associates and any guarantors; (b) The earnings or 
cashflow of the applicant; or (c) Where applicable, any equity or 
collateral of the applicant.
    First, SBA is incorporating into the regulation a new requirement 
that SBA Lenders must use appropriate and prudent generally acceptable 
commercial credit analysis processes and procedures consistent with 
those used for their similarly-sized, non-SBA guaranteed commercial 
loans. In using such appropriate and prudent processes and procedures, 
SBA Lenders will be required to underwrite SBA loans in the same manner 
in which the SBA Lenders underwrite their similarly-sized, non-SBA 
guaranteed commercial loans.
    SBA received 48 comments on this amendment. Twenty-seven of the 
comments supported the proposed changes as-is or that expressed support 
and requested modifications; twenty comments expressed opposition; and 
one comment sought clarification on the changes without offering a 
position of support or opposition. Some comments, including one from a 
trade group, expressed concern that, where SBA requires SBA Lenders to 
underwrite SBA loans in the same manner in which they underwrite their 
similarly-sized, non-SBA guaranteed loans, SBA Supervised Lenders and 
CDCs will not have processes and procedures for underwriting non-SBA 
guaranteed commercial loans because they only make SBA guaranteed 
loans. The trade group expressed concern that, if the SBLC Proposed 
Rule is adopted, the number of SBA Supervised Lenders could be greatly 
expanded at the same time SBA's requirements for a consistent 
underwriting framework are abandoned. The trade group expressed concern 
that SBA Supervised Lenders will be able to decide individual loan 
applications based completely on their own credit policies and 
practices that would result in the deterioration of the 7(a) loan 
portfolio's credit quality and adverse impacts to borrower and 7(a) 
Lender fees while possibly creating the need for Congress to provide 
appropriations to cover the increased costs of 7(a) loans. Other 
comments argued that allowing SBA Supervised Lenders and CDCs that only 
make SBA-guaranteed loans to set their own policies would create an 
unfair playing field for these lenders over federally-regulated lenders 
that must apply credit policies in accordance with their federal 
regulator's standards. SBA Supervised Lenders and CDCs (as defined in 
13 CFR 120.10) that do not make non-SBA guaranteed commercial loans 
will continue as they do now, to submit their credit policies, 
including credit scoring models, for review by SBA prior to approval to 
participate in the program(s), during lender oversight and review 
processes, when proposing any changes to their policies or practices, 
in accordance with Loan Program Requirements as defined in 13 CFR part 
120. SBA may at its discretion review the policies of any participating 
SBA Lender to ensure appropriate use of the policies and procedures.

[[Page 21077]]

    Some comments argued against the elimination of the review of 
``character and reputation'' in lending criteria, fearing past 
bankruptcies will not be adequately captured in underwriting, or that 
people with a past background of criminal behavior are likely to lapse 
back into criminal activities that could place the loan repayment at 
risk. Some comments expressed concern that an error by a lender or 
credit reporting agency could unfairly negatively impact an 
individual's or entity's credit history, and without consideration of 
character or reputation, the individual or entity may be denied a loan 
that they would have otherwise received. For SBA, ``character'' is used 
to determine whether an individual may have past criminal history or 
activities that may pose a risk to repayment ability. However, the 
lending industry uses character and credit history interchangeably, 
which creates confusion as to which factor is more relevant. In order 
to provide an objective rationale for credit review, the credit history 
has clearer meaning and relevance in loan underwriting. The use of 
reputational risk is subject to individual interpretation where an 
objective measure such as credit history, as a component of loan 
underwriting and credit review results in less variability. SBA's 
regulations set a minimum standard, beyond which SBA Lenders may take 
additional steps in underwriting a loan, including considering 
mitigating factors for negative credit histories, such as a reporting 
error by a credit reporting agency. SBA currently has a regulation at 
Sec.  120.110 that addresses criminal background. Additionally, SBA 
Lenders may continue to make their own credit decisions based on the 
criminal background of an applicant and its associates.
    Some comments, including one from a trade group, opposed allowing 
lenders to use their own business credit scoring models for 7(a) loans 
of all sizes. However, SBA will only permit those business credit 
scoring models that are predictive of the borrower's ability to repay 
the loan at the proposed loan sizes, and SBA Lenders may continue to 
underwrite loans without using credit scoring models. Additionally, SBA 
will provide guidance in Loan Program Requirements stating the maximum 
loan sizes that may be underwritten using credit scoring and what other 
credit factors must be addressed in addition to documenting a 
satisfactory credit score.
    One trade group and several comments expressed concern that SBA may 
impose a minimum credit score requirement and argued that traditional 
underwriting can overcome the reasons that an applicant or individual 
may have a low credit score. Other comments stated that lenders who 
continue to fully underwrite their loans will be on an uneven playing 
ground versus those lenders that rely on credit scoring models. These 
commenters stated that traditional comprehensive credit underwriting is 
more reliable than credit scoring models. Some of the comments in 
support of the revisions stated the proposed rule will allow SBA to 
fully leverage the process, skillset and experience of participating 
lenders without constraining them with SBA-specific lending criteria 
and will align lender processes for guaranteed and non-guaranteed 
loans. SBA did not propose to include a requirement for a minimum 
credit score in the proposed rule.
    SBA has historically provided lenders with an alternative 
underwriting path that may be used to fully underwrite a loan where the 
applicant has an unacceptable credit score, see for example, the 7(a) 
Small Loan delivery method and the Community Advantage Pilot Program. 
SBA considered the comments regarding traditional credit underwriting 
being more reliable; however, technological advances and modeling are 
providing more accurate methods of calculating risk, and lenders 
employing these measures are better able to provide small businesses 
access to capital, especially those businesses owned by underserved 
communities. The revisions provide options to SBA Lenders that 
incorporate the use of modern underwriting tools currently employed in 
the lending industry.

Section 120.160--Loan Conditions

    Current Sec.  120.160(c) states that for 7(a) and 504 loans SBA 
requires hazard insurance on all collateral and does not distinguish 
this requirement by loan size. SBA has determined that the hazard 
insurance requirement can be burdensome for the smallest businesses 
borrowing the smallest amount of money. SBA proposed to modify the 
requirement for hazard insurance for all 7(a) and 504 loans $150,000 
and under to create flexibility for SBA Lenders. SBA proposed to 
include guidance in the Loan Program Requirements for loans of $150,000 
or under that SBA Lenders must follow the hazard insurance policies and 
procedures they have established and implemented for their similarly-
sized, non-SBA-guaranteed commercial loans. For all loans greater than 
$150,000, SBA stated it will continue to require hazard insurance on 
all collateral. SBA Lenders must continue ensuring that borrowers 
obtain flood insurance per Sec.  120.170 when required under the Flood 
Disaster Protection Act of 1973 (Sec. 205(b) of Pub. L. 93-234; 87 
Stat. 983 (42 U.S.C. 4000 et seq.)).
    SBA received 43 comments on the proposed revision. Thirty-eight 
comments supported the proposed change as-is or supported the change 
with some modifications, and five comments opposed the proposed change. 
Some comments stated that regardless of loan amount, hazard insurance 
should be required to mitigate risk for all loans, or for all loans 
where real estate or improved real estate is collateral, or for all 
loans where equipment is being purchased with loan proceeds. Other 
comments stated that $150,000 as a threshold is too low, and suggested 
the threshold should be set at $500,000, because even with hazard 
insurance in place, the lender and/or SBA's recovery on assets in this 
dollar range is minimal after the costs of liquidation and litigation 
are considered. SBA agrees with the comments that state the threshold 
for requiring hazard insurance should be set at a higher level. 
Therefore, SBA is revising the rule to require hazard insurance for 
collateral on 7(a) loans greater than $500,000 and 504 projects greater 
than $500,000. SBA will include guidance in the Loan Program 
Requirements for loans of $500,000 or under that SBA Lenders must 
follow the hazard insurance policies and procedures they have 
established and implemented for their similarly sized, non-SBA-
guaranteed commercial loans.
    Some comments expressed concern that SBA would not honor a guaranty 
purchase request if an event such as a fire caused a borrower to 
default on a loan. SBA would not cite lack of hazard insurance as a 
reason to deny a guaranty purchase request if the SBA Lender was acting 
in accordance with Loan Program Requirements. For example, in the 
scenario where a loan is $500,000 or under and the use of proceeds is 
for working capital, and the lender's policy for similarly-sized, non-
SBA guaranteed loans is that it does not require hazard insurance for 
working capital loans, if a calamitous event such as a fire occurs and 
the borrower defaults on the loan because it is unable to resume 
business due to a lack of hazard insurance, SBA would not cite lack of 
hazard insurance as a reason to deny the guaranty purchase request. 
Other comments supported requiring lenders to follow their own hazard 
insurance policy on similarly-sized, non-SBA guaranteed commercial 
loans, with one comment stating the revision will align lender 
processes for guaranteed and non-

[[Page 21078]]

guaranteed loans. For the reasons stated above, SBA is moving forward 
with the rule applying the $500,000 threshold.
    Some comments, including one from a trade group representing hazard 
insurance providers, requested that SBA clarify whether the amendment 
would apply to loans that are already in existence and whether lenders 
could apply the amendment to a loan once the outstanding balance is 
paid down to the $150,000 threshold. SBA will provide further guidance 
in its Loan Program Requirements. Some of these comments requested that 
SBA make further changes to its requirements for flood insurance, which 
is outside the scope of the rule.

Section 120.193--Reconsideration After Denial

    Under current Sec.  120.193, the process for reconsideration after 
denial of a loan application or loan modification request in the 7(a) 
and 504 Loan Programs states that final reconsideration is made by the 
Director of the Office of Financial Assistance. To facilitate fair and 
expeditious reconsiderations, SBA is revising this regulation to state 
that the Director of the Office of Financial Assistance or the 
Director's designee(s) may make the final decision on reconsideration. 
From time to time, SBA may change the designee(s) and would do so in 
accordance with published Delegations of Authority. Further, SBA is 
revising this regulation to provide the Administrator with the 
authority, solely within the Administrator's discretion, to review a 
reconsideration request and make the final Agency decision. Finally, 
SBA is revising this regulation to state that the Administrator's 
discretionary authority does not create any additional appeal rights 
for the applicant that are not otherwise specified in regulation.
    SBA received 34 comments on the proposed rule change. Twenty-one 
comments supported the proposed rule as-is, and eight comments 
supported the rule but requested modifications. Most of the comments 
requesting modification supported allowing the Director to designate a 
career employee (such as the Chiefs of 7(a) or 504 Loan Policy) to make 
the final Agency decision but opposed allowing the Administrator to 
make the final Agency decision for fear that this would politicize 
decision making. Five comments opposed any delegation because they 
stated the decision-making authority should stay with the Director. 
Other comments stated SBA should expand the delegation of authority to 
include servicing actions. For the reasons stated above, SBA is moving 
forward with the rule to permit the delegation of Authorities.

Section 120.202--Restrictions on Loans for Changes of Ownership

    Current Sec.  120.202 restricts borrowers from using 7(a) loan 
proceeds to purchase a portion of a business or a portion of another 
owner's interest. SBA is revising this section to allow borrowers to 
use 7(a) loan proceeds to fund partial changes of ownership in addition 
to full changes of ownership. The revision will allow a borrower to 
purchase a portion of the business or a portion of an owner's interest 
in a business, or to purchase the entire business or an owner's entire 
interest. A borrower could also purchase the partial or entire 
interests of multiple owners. This revision will allow borrowers to use 
7(a) loan proceeds to fund partial changes of ownership and will help 
provide employees a path to ownership.
    SBA received 48 comments regarding the proposed changes to 
Sec. Sec.  120.130 and 120.202 to permit partial changes of ownership, 
including 15 comments supporting the proposal as-is and another 17 
comments, including one from a trade group, supporting the proposal and 
requesting that the 504 Loan Program also be permitted to fund partial 
changes of ownership. The 504 Loan Program only permits loans for a 
change of ownership when the 504 project finances only the costs 
associated with eligible long-term fixed assets. As stated in 
Sec. Sec.  120.801(c) and 120.934, generally, permanent financing of 
the Project consists of a loan made with the proceeds of a CDC 
Debenture for up to 40 percent of the Project costs collateralized by a 
second lien on the Project Property, and a Third Party Loan with a 
first lien position. The debentures are then sold to investors that 
expect the debenture to be secured by a second lien position on 
collateral. The success of the 504 Loan Program is dependent on 
investors being willing to purchase these debentures. Loans for partial 
changes of ownership will generally have collateral and collateral lien 
positions that are incompatible with the debenture sale process. 
Amending the 504 Loan Program to permit 504 loans to fund partial 
changes of ownership is outside the scope of the rule.
    One trade group appeared to be neutral as to whether SBA should 
implement the proposed change, but stated if SBA moves forward with 
this proposal, SBA should state clearly that 7(a) funds may not be used 
for investment purposes. It should be noted that SBA already has a 
regulation at Sec.  120.130(d) that states SBA will not authorize nor 
may a borrower use loan proceeds for the purpose (including the 
replacement of funds used for any such purpose) of investments in real 
or personal property acquired and held primarily for sale, lease, or 
investment (except for a loan to an Eligible Passive Company or to a 
small contractor under Sec.  120.310).
    The remaining 15 comments opposed the amendment. One trade group 
stated the principle underlying the current prohibition against 
distributing proceeds of a 7(a) loan to an associate of the applicant 
business protects against sham transactions where an individual 
personally receives 7(a) loan proceeds while continuing to play a key 
role in the operations of the business. One comment expressed 
opposition to the rule, stating that a loan for the purpose of a 
partial change of ownership is by its very nature a personal loan, not 
a business loan. One of the examples provided in one of the comments 
was a business with three owners, where one of the owners wishes to 
retire and only one of the remaining owners wishes to purchase the 
outgoing owner's portion of the business. The comment stated there is 
no benefit to the third owner that was remaining on as owner of the 
business but that was not purchasing the outgoing owner's portion of 
the business. However, since SBA's Standard Operating Procedure 50 10 6 
went into effect on October 1, 2020, SBA has permitted one or more 
current owners to purchase the entire interest of another current 
owner, resulting in 100 percent ownership of the business by the 
remaining owners; in this type of change of ownership, the small 
business and the individual owner(s) who is acquiring the ownership 
interest must be co-borrowers while the remaining owner(s) remain 
unaffected. The same comment expressed the concern that the lien may 
not be properly perfected. SBA's Loan Program Requirements currently 
address adequacy of collateral, including loans for changes of 
ownership between existing owners, working capital, purchase of stock, 
and intangible assets such as good will. SBA will provide guidance on 
adequacy of collateral for loans for partial changes of ownership in 
its Loan Program Requirements and lender outreach activities. The same 
comment provided alternative solutions for ensuring the success of 
changes of ownership, including some already under consideration in the 
proposed rule, such as allowing greater flexibility in equity 
requirements in Sec.  120.150.
    Several comments requested clarifying information that SBA will 
include in Loan Program Requirements

[[Page 21079]]

and in lender outreach, including training events. For example, several 
comments asked whether sellers would be allowed to remain as employees 
in a complete or partial change of ownership. Some of these comments 
stated that allowing the seller to remain in place, either as a part 
owner or employee, will allow the seller to provide guidance and 
expertise to ensure the success of the business. For a complete change 
of ownership, SBA's Loan Program Requirements currently permit the 
seller to remain as an officer, director, stockholder or Key Employee 
of the business for a period not to exceed 12 months, and SBA also 
currently permits a seller to remain as an employee indefinitely in the 
rare circumstance when the seller will not be an officer, director, 
stockholder or Key Employee of the business. For partial changes of 
ownership, SBA intends to allow the selling owner to remain as an owner 
and involved in the day to day business, including as an officer, 
director, Key Employee, or employee.
    Some comments inquired whether the partial change of ownership 
would be treated similarly to a stock purchase transaction where both 
the individual purchasing ownership and the business entity are 
required to be co-borrowers on the loan. SBA will require the business 
to be the borrower or co-borrower with any entity purchasing a partial 
interest. SBA will provide further guidance on these and other 
questions in its Loan Program Requirements and lender outreach 
activities.
    As described above, SBA received comments on section 120.130(a), 
which currently prohibits payments, distributions, or loans to 
associates of the applicant (except for ordinary compensation for 
services rendered). These comments pointed out that in order to 
facilitate the use of 7(a) loan proceeds to be used for partial changes 
of ownership, section 120.130 paragraph (a) would also need to be 
modified to permit payments, distributions, or loans to associates of 
the applicant. SBA had already addressed the prohibition in Sec.  
120.130(a) that prohibits payments, distributions, or loans to 
associates of the applicant by the proposed revision to Sec.  120.202, 
which, as proposed, would state: ``Notwithstanding Sec.  120.130(a), a 
Borrower may use 7(a) loan proceeds to purchase a portion of or the 
entirety of an owner's interest in a business, or a partial or full 
purchase of a business itself.'' However, the comments make it clear 
that there would be some confusion in interpreting the proposed 
revisions to Sec. Sec.  120.130 and 120.202 regarding restrictions on 
uses of proceeds for partial changes of ownership. Accordingly, SBA is 
revising Sec.  120.130, paragraph (a) for clarity as stated above, and 
is revising the proposed revision to Sec.  120.202 to delete the 
introductory phrase ``Notwithstanding Sec.  120.130(a)''.

Section 121.301--What size standards and affiliation principles are 
applicable to financial assistance programs?

    Section 121.301 states the size standards and affiliation 
principles that are applicable to SBA's financial assistance programs. 
Paragraph (f) details how affiliation principles are applied for the 
7(a) Loan Program, the 504 Loan Program, the Microloan Program, the ILP 
Program, the Business Disaster Loan Programs (except for the COVID EIDL 
Disaster Loan Program),\1\ and the SBG Program. This paragraph 
currently has seven sub-paragraphs, each of which details a separate 
affiliation principle that must be applied to the applicant and other 
entities to determine whether the entities are affiliated. The 
determination of affiliation is necessary to ensure that an applicant 
is ``small'' for purposes of eligibility for SBA financial assistance 
and to ensure that the applicant (including affiliates) does not exceed 
the maximum guaranty amount available. Currently, paragraphs (f)(1) 
through (f)(7) consider: (1) affiliation based on ownership, including 
the principle of control of one entity over another; (2) affiliation 
arising under stock options, convertible securities, and agreements to 
merge, including the principle of control of one entity over another; 
(3) affiliation based on management, including the principle of control 
of one entity over another; (4) affiliation based on identity of 
interest between close relatives; (5) affiliation based on franchise 
and license agreements, including the principle of control of one 
entity over another; (6) determining the concern's size; and (7) 
exceptions to affiliation.
---------------------------------------------------------------------------

    \1\ The affiliation principles for the COVID EIDL Disaster Loan 
Program are contained in paragraph (g) of Section 121.301.
---------------------------------------------------------------------------

    SBA is revising Sec.  121.301 affiliation provisions to simplify 
the program requirements, streamline the application process for SBA's 
programs, and facilitate the review of such applications. SBA is 
specifically removing the principle of control of one entity over 
another as a separate basis for finding affiliation because the concept 
of control as it exists requires understanding and expert consideration 
of business entity relationships well beyond what is owned by the 
applicant business or its owners. These considerations are complex and 
require judgement calls that confuse and unnecessarily burden small 
business applicants and lenders, and ultimately result in inconsistent 
application of this concept. For example, determining whether an entity 
has control over another requires in-depth analyses of the contractual 
relationships an applicant may have, including relationships 
established by franchise, license, and management agreements deemed 
necessary and appropriate by an independent small business owner to 
operate. The determination of whether one or more managers hired to 
assist the applicant small business have control over the business, and 
further requiring review of the business type and business ownership of 
family members who may be deemed affiliates based on NAICS code and 
proximity to the applicant increases costs, delays application 
processing, and/or prevents an otherwise eligible small business from 
receiving support. SBA instead believes that affiliation based on 
ownership is the customary basis for considering who is deemed to 
control a business. Accordingly, SBA has determined that issues of 
control and familial relationships as separate bases for finding 
affiliation are not necessary.
    SBA is revising Sec.  121.301 to add an introductory paragraph at 
the beginning to include the Small Business Act definition of a small 
business concern 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. SBA 
is revising Sec.  121.301(f)(1), ``Ownership,'' to remove the principle 
of control of one entity over another absent ownership over that entity 
when determining affiliation. SBA is expanding upon the definition of 
``ownership'' under paragraph (f)(1) to clarify the thresholds of 
ownership at which SBA considers an applicant to be affiliated with an 
individual or another business. SBA is also clarifying that certain 
instances of affiliation by ownership will only arise if the applicant 
and another business operate in the same three-digit NAICS subsector to 
restrict affiliates to businesses in the same field. Paragraph 
(f)(1)(i) will state that businesses in which the applicant is a 
majority owner are affiliates of the applicant. Paragraph (f)(1)(ii) 
describes affiliation with businesses that own a majority of the 
applicant as well as

[[Page 21080]]

businesses in the same three-digit NAICS subsector that are majority-
owned by the applicant's owner. Paragraph (f)(1)(iii) describes 
affiliation with another business when the applicant and the other 
business are both majority-owned by the same individual and operate in 
the same three-digit NAICS subsector. Paragraph (f)(1)(iv) describes a 
20 percent threshold of ownership for affiliation with the applicant 
when the applicant does not have a majority owner if a 20 percent owner 
also operates in the same three-digit NAICS subsector as the applicant. 
Paragraph (f)(1)(v) will state that if the applicant does not have a 
majority owner and an individual owns 20 percent 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. Paragraph (f)(1)(vi) will state that ownership interests of 
spouses and minor children will be combined when determining ownership 
interest (as interests may be held in trust by parents for minors). 
Finally, SBA is revising Paragraph (f)(1)(vii) to state that SBA will 
analyze the pro rata ownership of entities to determine affiliation and 
provide an example of the combined interest of an individual and an 
entity that is wholly-owned by the same individual.
    Because SBA is revising its regulation generally by removing the 
principle of control of one entity over another as a separate basis for 
finding affiliation, SBA is also revising Sec.  121.301(f)(2), ``Stock 
options, convertible securities, and agreements to merge,'' paragraphs 
(f)(2)(i) and (iv). Where paragraph (f)(2)(i) currently states that SBA 
considers stock options, convertible securities, and agreements to 
merge (including agreements in principle) to have a present effect on 
the power to control a concern, the revised paragraph (f)(2)(i) will 
state that, for purposes of that paragraph, the items will have a 
present effect on ownership of the entity. SBA is revising paragraph 
(f)(2)(iv) by deleting the first sentence where SBA currently states 
SBA will consider whether an individual, concern or other entity that 
controls one or more other concerns cannot use options, convertible 
securities, or agreements to appear to terminate such control before 
actually doing so. SBA is removing the first sentence of paragraph 
(f)(2)(iv) because it is unnecessary; the remaining sentence of the 
paragraph clearly states that SBA will not give present effect to the 
ability of an entity to divest in the future to avoid a finding of 
ownership.
    SBA is removing paragraph (f)(3), affiliation based on management, 
because SBA is revising its regulation generally by removing the 
principle of control of one entity over another without ownership from 
consideration of affiliation. SBA believes it should not interfere in a 
business owner's right to enter into a service agreement with a 
management company. The decision to hire a management company is the 
sole responsibility of the independent business owner(s).
    SBA is also removing paragraph (f)(4), affiliation based on 
identity of interest, because SBA believes it is inherently unfair and 
inappropriate to require close relatives that do not have an ownership 
interest in the applicant to provide financial statements for review by 
a lender and by SBA in determining the size of the applicant business. 
For example, the current rule requires a sole proprietor who is 
requesting an SBA direct or guaranteed loan to provide their sibling's 
business's financial statements for review when the sibling is in the 
same or similar industry in the same geographic area. SBA believes this 
requirement imposes a chilling effect on applicants that may be forced 
to consider alternative predatory lending sources because relatives 
bear no legal responsibility to disclose their business financial 
statements for transactions in which they have no ownership interest. 
However, as stated above, SBA is combining the ownership interests of 
spouses and minor children when determining affiliation by ownership.
    SBA is removing paragraph (f)(5), affiliation based on franchise 
and license agreements. Because SBA is removing the principle of 
control of one entity over another from its affiliation consideration, 
this paragraph is no longer needed. Upon the effective date of this 
rule, SBA will no longer publish the SBA Franchise Directory.
    As is the requirement for all loans, SBA Lenders will continue to 
be required to examine Franchised businesses for affiliation based on 
ownership. For example, when lending to a Franchised business, the SBA 
Lender must determine who owns the applicant business and any 
businesses the applicant owns in accordance with these regulations. 
However, neither the SBA Lender nor SBA will review the applicant 
Franchised business for affiliation with other entities beyond 
ownership; the applicant business will not be considered affiliated 
with the Franchisor or other Franchised businesses except by ownership.
    SBA received 54 comments on the proposed revisions of Sec.  
121.301, paragraph (f). Twelve comments expressed overall support for 
the proposed rule. Thirty-four comments requested modifications to the 
proposed rule, with the most frequent comment expressing opposition to 
no longer publishing an SBA Franchise Directory. The remaining eight 
comments expressed general opposition.
    One comment expressed support of all proposed affiliation changes, 
but asked how lenders would determine if a business is dominant in its 
field of operation. This comment is referencing the introductory 
paragraph that SBA is adding to Sec.  121.301 that includes the Small 
Business Act definition of a small business concern as one which is 
independently owned and operated, and not dominant in its field of 
operation. This introductory paragraph was added to help frame the 
requirements at Sec.  121.301(f). SBA interprets the statutory 
definition of a small business concern as requiring, in certain 
circumstances, the inclusion of other entities known as Affiliates that 
are owned by the applicant or an owner of the applicant in determining 
the size of the applicant.
    Several comments stated support of the overall revisions to Sec.  
121.301 but objected to the inclusion of NAICS codes in the proposed 
rule for Sec.  121.301(f)(1)(ii) through (v). One comment stated that 
SBA Lenders use affiliation as a guide to determine which entities to 
analyze for credit purposes and that removing industries outside of an 
applicant's NAICs code will skew the SBA Lender's analysis. However, 
SBA provides the criteria for lenders to underwrite loans in Sec.  
120.150. SBA Lenders have historically and will continue to be required 
to follow the regulation at Sec.  120.150 when analyzing a loan for 
credit purposes.
    A trade group expressed concerns that the proposed amendments may 
result in larger, more complex, and more sophisticated business 
structures qualifying for multiple SBA-guaranteed loans. The trade 
group stated that it does not oppose the proposed change regarding 
ownership thresholds. However, the trade group also stated it does not 
concur with removing control as part of the consideration of whether 
two entities are affiliated. The comment stated the existing regulatory 
requirements for control should continue because they believe both 
common ownership and common control are essential factors in 
determining whether a small business operates on an independent basis.
    Regarding the proposed change to paragraph (f)(1)(vii), one comment 
stated that when multiple business entities own an applicant business, 
and

[[Page 21081]]

when the entity owners are owned by entity owners, it can be difficult 
to trace back to the natural person to determine percentage of 
ownership. Currently, SBA requires this disclosure of the applicant 
owners to identify which owners are required under the 20 percent 
ownership rule to guarantee a loan. The inclusion of this information 
in the Final Rule merely codifies what is currently a program 
requirement. The vast majority of SBA loans are made to businesses with 
a simple ownership structure, and the existence of a very small 
percentage of applicants with a complex ownership structure as compared 
to SBA's overall business loan portfolio is not a compelling reason to 
remove the requirement from this final rule.
    One comment stated that the revisions will cause all Eligible 
Passive Companies (EPCs) and Operating Companies (OCs) to be 
unaffiliated. While the ownership of an EPC may be different from the 
OC, the EPC's sole purpose is to hold assets for the benefit of an 
eligible OC that is the qualifying entity on which cash flow and 
repayment of the loan is based. The OC is required to be a co-borrower 
or guarantor on any loan to an EPC.
    Regarding the proposed change to paragraph (f)(3), affiliation 
based on management, SBA received ten comments, with six comments 
supporting the change as-is, three comments opposing the change, and 
one comment requesting clarification. Those that opposed the change, 
including a trade group, stated that this would allow SBA loan proceeds 
to fund investors that would passively manage businesses. However, as 
stated above, SBA already has a regulatory prohibition on funding 
investors at Sec.  120.130, which states SBA will not authorize nor may 
a borrower use loan proceeds for the purposes (including the 
replacement of funds used for any such purpose) of investments in real 
or personal property acquired and held primarily for sale, lease, or 
investment.
    Regarding the proposed change at Sec.  121.301(f)(4), affiliation 
based on identity of interest, there was nearly universal support for 
this change, except for one comment that opposed the proposed revision, 
stating repeal of the identity of interest rule is an overcompensation 
by SBA that will open the program to abuse by unscrupulous borrowers 
and unwitting lenders. SBA does not agree with this concern.
    Most of the comments that opposed the revisions to Sec.  121.301 
were focused on the removal of paragraph(f)(5), affiliation based on 
franchise and license agreements and specifically opposed SBA's 
intention to no longer publish an SBA Franchise Directory while 
requiring SBA Lenders to retain the responsibility for ensuring that 
the applicant meets all Loan Program Requirements, including but not 
limited to obtaining proper lien position on collateral and ensuring 
the applicant does not have discriminatory hiring practices. Of the 53 
comments that directly addressed the proposed changes to Sec.  
121.301(f)(5), only four comments supported the proposal as-is with the 
remainder expressing opposition to the proposed change mainly on the 
grounds that they opposed discontinuance of an SBA Franchise Directory.
    The general concern was that lenders would be required to determine 
franchise eligibility. If SBA were to discontinue publishing a 
franchise directory without modifying the current affiliation rules, 
SBA agrees that SBA would be transferring the responsibility for 
determining affiliation based on control to lenders. However, the 
comments did not take into consideration the fact that SBA is removing 
as part of this rule the concept of affiliation based on control, 
including control by a Franchisor of a franchisee's business. In point 
of fact, as a result of this rule, SBA will update Standard Operating 
Procedure 50 10, Lender and Development Company Loan Programs, by 
deleting Part 2, Section A, Chapter 1, Paragraph D. 6, Affiliation 
Based on Franchise, License, Dealer, Jobber, and Similar Agreements, 
and eliminate SBA's Addendum to Franchise Agreement and its process 
identified therein. SBA has determined that franchise business models 
would not be made ineligible for SBA business loans based on Sec.  
120.110, which states the businesses that are ineligible for SBA 
business loans. For example, ineligible businesses include, among 
others, non-profit organizations, life insurance companies, government 
entities, speculative businesses (such as wildcatting), use of proceeds 
for stock and real estate speculation, passive businesses, and prurient 
businesses.
    SBA Lenders must evaluate all applicants for eligibility and must 
ensure proper lien position on all loans, regardless of whether the 
applicant is a franchise or non-franchise business. Under the current 
rules, if SBA determines the franchisor exercises excess control over 
the franchisee, SBA will consider the franchisor and franchisee to be 
affiliated, which in most cases would mean the applicant would not be 
eligible for an SBA loan because it would not meet SBA's size 
standards. The purpose for publishing an SBA Franchise Directory was to 
prevent SBA Lenders and SBA from repeatedly reviewing the same 
franchise documents for the issue of excessive control. Because SBA was 
already reviewing the franchise documents for the issue of excessive 
control, SBA also reviewed the franchise documents for other business 
model eligibility requirements that apply to all applicants, including 
non-franchisee applicants, such as non-discriminatory hiring practices 
and providing the applicant purchaser the right to encumber the 
applicant's property with liens. These revisions remove the principle 
of control of one entity over another from consideration of 
affiliation; therefore, the mere fact that an applicant may be a 
franchisee is not in itself a reason that would render the applicant 
ineligible for an SBA loan, and thus there is no longer a compelling 
reason to maintain the SBA Franchise Directory. Additionally, the mere 
fact that a franchise is listed on the SBA Franchise Directory does 
not, under current policies nor under the proposed policies, relieve 
the SBA Lender from determining whether the applicant meets all 
eligibility and other Loan Program Requirements, including but not 
limited to; certifying that the applicant does not have the ability to 
obtain some or all of the requested loan funds on reasonable terms from 
non-Federal, non-State, or non-local government sources, ensuring that 
applicants are U.S. citizens or Legal Permanent Residents and that the 
applicant business is located in the United States, obtaining personal 
and corporate guaranties, confirming that the applicant business has 
the ability to repay the loan through cash flow of the business, has 
eligible uses of proceeds, verifying financial information, obtaining 
proper collateral and lien position, determining whether there is a 
direct or indirect impact on historic properties, compliance with 
environmental policies and procedures, and closing the loan in 
accordance with SBA program requirements.
    One comment stated that SBA's review of franchise documents for 
excess control by the franchisor has led to indirect benefits for 
franchisees, which ``resulted in significant improvements in franchise 
lending'' providing greater assurance that the franchisee has the right 
to profit from their efforts and that the franchisor would not impose 
objectionable terms such as approvals on changes of ownership, forced 
sale of assets, restrictive covenants on real estate, and control of 
employees. While SBA

[[Page 21082]]

appreciates this perceived indirect benefit, SBA maintains that it is 
solely an applicant's business decision whether it wishes to operate as 
a franchise or non-franchise business. All purchase agreements, even 
purchase agreements of non-franchise businesses, may potentially 
include these terms that the comment describes as objectionable, and it 
is incumbent on all parties to fully understand the terms of any 
contract they sign. Further, SBA does not have the statutory authority 
to act as a regulator of franchises, only guarantees a small percentage 
of loans to franchisees relative to the number of franchise businesses 
that are started and operate in the U.S., and only uses the Federal 
Trade Commission definition of franchise in SBA's policies and 
procedures. For the reasons stated above, SBA is moving forward with 
the rule as proposed.

Compliance With Executive Orders 12866, 12988, 13132, and 13563, the 
Paperwork Reduction Act (44 U.S.C., Ch. 35), the Congressional Review 
Act (5 U.S.C. 801-808), and the Regulatory Flexibility Act (5 U.S.C. 
601-612)

Executive Order 12866

    The Office of Management and Budget has determined that this rule 
is a ``significant regulatory action'' under Executive Order 12866. SBA 
performed a comprehensive Regulatory Impact Analysis in the proposed 
rule for the public's information. Because SBA is not substantially 
changing any of the proposed amendments, the final analysis is 
unchanged and is synopsized below. Each section begins with a core 
question.
A. Regulatory Objective of the Proposal
    Is there a need for this regulatory action?
    SBA performed a comprehensive cost benefit analysis in the proposed 
rule. SBA is moving forward with only minor adjustments that will not 
have a significant impact on the cost benefit analysis that was 
published in the proposed rule; therefore, the cost benefit analysis is 
updated where appropriate or synopsized below.
    The Agency believes it needs to streamline and reduce regulatory 
burdens to facilitate robust participation in the business loan 
programs that assist small and underserved U.S. businesses and the 
disaster loan programs that assist businesses of all sizes with 
recovery from disasters.
    Regarding modernization of lending criteria, as a result of the 
emergency lending programs mandated to address economic impacts of the 
pandemic, SBA significantly leveraged the use of technology in loan 
delivery to capture efficiencies that can be applied across programs to 
increase access and lower costs for both participating lenders and the 
public. SBA also understands that lenders are currently leveraging data 
analytics tools and machine learning modelling in their conventional 
lending criteria models, particularly for small dollar loans, and that 
by modernizing SBA's lending criteria to match lending practices 
already being implemented by its participating lenders, SBA will 
encourage more lender participation in its programs. For these reasons, 
among others, SBA is moving forward with the changes to SBA's lending 
criteria rules at 13 CFR 120.150.
    By dispensing with the requirement for hazard insurance for all 
7(a) and 504 loans of $500,000 or less, SBA will eliminate a burdensome 
regulatory requirement for small loans while providing SBA Lenders with 
the flexibility to use their own policies for similarly-sized non-SBA 
guaranteed loans regarding hazard insurance on these loans.
    By permitting the Director, Office of Financial Assistance, to 
delegate reconsideration requests to a designee, SBA will facilitate 
fair and expeditious review of reconsideration requests and provide 
finality to applicants that are in the process of making important 
financial decisions.
    SBA is revising its affiliation regulations in response to 
continuing requests by SBA's participating lenders and the public. SBA 
believes that revising its affiliation regulations will result in 
expansion of credit to those who cannot obtain credit elsewhere and 
increased understanding of and compliance with program rules while 
decreasing time spent reviewing an applicant for eligibility.
    There is also a need for SBA to address financing for changes of 
ownership. Orderly transitions of business ownership are beneficial 
both to the small business and its employees. Employees acquiring 
partial ownership interest in small businesses assists with transitions 
of ownership, especially when there is more than one current owner and 
one of the current owners intends to sell their equity stake in the 
small business to one or more employees who may not have an equity 
ownership interest at that time. The small business benefits by 
remaining in operation when it might otherwise be forced to close, and 
the employees benefit by having a path to ownership in a small business 
that remains in operation. Partial changes of ownership among existing 
owners of a small business permit such businesses to attract new 
employees as partial owners. Financing for changes of ownership also 
allows family members to purchase partial ownership in a family-run 
small business to ensure continuation of the small business after the 
retirement or death of an owner. Currently, SBA does not fully meet the 
financing needs of small businesses regarding partial changes of 
ownership due to current restrictions, necessitating this rule.
    Historically, SBA has permitted loan proceeds for use only in three 
situations involving a change of ownership: (1) A complete change of 
ownership; (2) a Partner Buyout; and (3) where an ESOP purchases a 
controlling interest (51 percent or more) in the employer small 
business from the current owner(s). Outside of loans to ESOPs, SBA's 
current regulations do not permit 7(a) loan proceeds to be used for 
partial changes of ownership.
    Over the past 4 completed fiscal years (FY 2018 through FY 2021), 
SBA approved 31,940 7(a) loans where loan proceeds were used to affect 
a change of ownership. ESOP loans (loans to assist an ESOP trust in 
acquiring 51 percent or more of the equity ownership in the small 
business concern) accounted for only 17 of the 31,940 loans used for a 
change of ownership in the four years between FY 2018 and FY 2021, or 
fewer than five loans per year. Therefore, ESOP loans have not made the 
anticipated impact in transitioning small businesses to employee 
ownership as originally intended by the Agency. For these reasons, SBA 
is moving forward with lifting the prohibition on partial changes of 
ownership. SBA will include detailed guidance in the Loan Program 
Requirements to accomplish partial changes of ownership.
    The changes will reduce regulatory burdens, modernize program 
delivery using data analytics tools and machine learning modelling, 
reduce the number of hours spent processing an application to deliver a 
loan for both SBA and lenders and increase access to capital.
B. Benefits and Costs of the Rule
    What are the potential benefits and costs of this regulatory 
action?
    SBA does not anticipate significant additional costs or impact on 
the subsidy to operate the 7(a), 504, Microloan, ILP, SBG and Business 
Disaster Loan Programs under these revisions to the regulations.
    SBA anticipates a minor impact to the subsidy as a result of 
approximately 800 new loans per year in 7(a) loan activity for loans 
involving a partial change of ownership. In revising SBA's lending

[[Page 21083]]

criteria at 13 CFR 120.150, SBA anticipates that modernizing SBA's 
lending criteria to include credit scoring will not compromise the 
credit quality of the overall 7(a) and 504 portfolios. When using a 
credit scoring model other than the FICO[supreg] Small Business Scoring 
Service\SM\ (SBSS) model, SBA Lenders must be able to validate the 
credit scoring model and must document that their credit analysis 
procedures are predictive of loan performance; therefore, no reduction 
in credit quality is anticipated as a result of using credit scoring 
models. Streamlining the number of criteria lenders consider when 
approving loans, and for regulated lenders, using the same commercial 
credit analysis processes and procedures consistent with those used for 
their similarly-sized, non-SBA guaranteed commercial loans will not 
negatively impact the credit quality of the 7(a) and 504 Loan Program 
portfolios and will provide a time saving ranging from zero to several 
hours per loan depending on the size and complexity of the loan. SBA 
anticipates that modernizing SBA's lending criteria and allowing SBA 
Lenders to use their own processes and procedures will result in an 
increase in the number of participating lenders and loans in both 
programs, which would mean increased access to capital for small 
businesses.
    The primary goal driving the revisions to 13 CFR 120.150 is to 
encourage and facilitate more lenders to make more small dollar loans. 
SBA believes these streamlined rules will result in increased lender 
participation, particularly for community banks, credit unions and 
other mission-based lenders that generally serve more rural communities 
and underserved populations with smaller dollar loans.
    By revising 13 CFR 120.160 to state that SBA requires hazard 
insurance only for loans greater than $500,000, SBA anticipates a de 
minimis impact on annual subsidy calculation for the 7(a) and 504 Loan 
Programs. The primary benefit to removing the requirement for hazard 
insurance on these small loans is to increase the speed with which 
lenders can disburse loan proceeds after loan approval. Hazard 
insurance is only impactful when it is protecting collateral. 
Currently, SBA does not require collateral for loans $25,000 or less, 
so these loans are not impacted by the revision to hazard insurance 
requirements. Further, lenders will continue to require hazard 
insurance for loans of $500,000 and under when tangible assets such as 
real estate or equipment are financed with the loan in accordance with 
their non-SBA guaranteed policies and federal regulators. As such, 
although lenders will continue to require hazard insurance in 
accordance with their similarly-sized non-SBA guaranteed policies, they 
will experience a time savings by no longer providing SBA with 
documentation of proof of hazard insurance as part of SBA's loan 
origination and monitoring requirements. Further, even with hazard 
insurance in place, the lender and/or SBA's recovery on assets in this 
dollar range is minimal after the costs of liquidation and litigation 
are considered. The benefit to SBA for requiring hazard insurance at 
this amount is minimal, while lenders will save time and be able to 
disburse loan proceeds more quickly after loan approval by using their 
own procedures and not having to provide additional documentation 
evidencing insurance to SBA.
    Revising 13 CFR 120.193 will allow the Director of the Office of 
Financial Assistance to delegate to a designee the authority to make 
final decisions on reconsideration after denial of a loan application 
or loan modification request in the 7(a) and 504 Loan Programs. SBA 
does not anticipate any additional costs or impact on the subsidy to 
operate the 7(a) and 504 Loan Programs under this final rule. 
Additionally, the number of loans impacted by this change is very low 
in comparison to the number of loans processed in both loan programs. 
On average, the 7(a) Loan Program accounts for 10 to 12 reconsideration 
requests per year, and the 504 Loan Program accounts for 28 to 41 
requests per year. For comparison, in fiscal year 2021, the 7(a) Loan 
Program approved 51,856 loans, and the 504 Loan Program approved 9,676 
loans. SBA Lenders and applicants will benefit in a faster turn time 
for decision-making.
    SBA does not anticipate significant additional costs or impact on 
the subsidy to operate the 7(a), 504, Microloan, ILP, SBG and Business 
Disaster Loan Programs under the revised regulations at 13 CFR 121.301 
regarding affiliation. Complex affiliation rules limit accessibility to 
SBA's business loan programs, with an outsized impact on underserved 
borrowers who may struggle to access traditional capital or other 
resources such as attorneys and certified public accountants. SBA 
anticipates that providing clear and streamlined regulatory guidance 
for its affiliation rules will result in an increase in the number of 
participating lenders and loans and will encourage more businesses to 
apply. SBA anticipates that participating lenders will spend less time 
screening applicants for eligibility under SBA Size Standards because 
lenders and applicants will readily be able to determine which entities 
they are affiliated with, and lenders will have fewer documents to 
examine.
C. Alternatives
    What alternatives have been considered?
    SBA considered eliminating even more regulatory burdens and 
determined the final rule strikes the right balance in responsibly 
streamlining regulations without substantially increasing the risk of 
waste, fraud, or abuse of the programs or otherwise threatening the 
integrity of the business loan programs or taxpayer dollars. Regarding 
affiliation, SBA has implemented several variations of its affiliation 
rules as discussed above, and SBA has determined the simplest 
affiliation rules were the least burdensome.
    SBA also considered limiting partial changes of ownership to 
employees of the business; however, the Agency believes this may 
restrict small businesses in need of additional expertise from 
providing a percentage of ownership as an incentive to recruit and 
retain new highly skilled employees. For example, an existing dental 
practice may recruit a new dentist by offering the dentist an equity 
ownership in the business as a hiring incentive. For this reason, SBA 
determined that partial changes of ownership should not be exclusive to 
existing employees of the business.

Executive Order 12988

    This action meets applicable standards set forth in sections 3(a) 
and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize 
litigation, eliminate ambiguity, and reduce burden. The action does not 
have preemptive effect or retroactive effect.

Executive Order 13132

    This rule does not have federalism implications as defined in 
Executive Order 13132. It will not have substantial direct effects on 
the States, on the relationship between the national government and the 
States, or on the distribution of power and responsibilities among the 
various levels of government, as specified in the Executive Order. As 
such it does not warrant the preparation of a Federalism Assessment.

Executive Order 13563

    A description of the need for this regulatory action and benefits 
and costs

[[Page 21084]]

associated with this action, including possible distributional impacts 
that relate to Executive Order 13563, are included above in the 
Regulatory Impact Analysis under Executive Order 12866.

Paperwork Reduction Act, 44 U.S.C. Ch. 35

    SBA has determined that this rule will require that the following 
forms be revised: SBA Form 1919, ``Borrower Information Form,'' SBA 
Form 1920, ``Lender's Application for Loan Guaranty for all 7(a) Loan 
Programs,'' SBA Form 1244, ``Application for Section 504 Loans,'' SBA 
Form 5--Disaster Business Loan Application, and SBA Form 5C--Disaster 
Home/Sole Proprietor Loan Application.
    SBA Forms 1919 and 1920 are approved under OMB Control number 3245-
0348. SBA Form 1244 is approved under OMB Control number 3245-0071. SBA 
Form 5 is approved under OMB Control number 3245-0017 and SBA Form 5C 
is approved under OMB Control number 3245-0018.
    SBA will revise SBA Form 1919, SBA Form 1920, and SBA Form 1244 to 
conform to the lending criteria changes at 13 CFR 120.150. When lenders 
choose to use a credit scoring model in accordance with 13 CFR 120.150, 
the estimated hour burden for lenders will decrease when the credit 
score incorporates consideration of certain lending criteria (e.g., the 
earnings and cashflow of an applicant), in which case those factors 
would not necessarily be separately considered by a lender unless 
otherwise specified by Loan Program Requirements. However, SBA expects 
that SBA Lenders will make more small dollar loans due to the ability 
to use credit scoring models, which increase the estimated overall 
burden hours due to the increase in number of loans. This reporting 
requirement will be included in the OMB information collection 
submissions for the affected forms. The other revisions to 120.150 
(i.e., requirement that SBA Lenders use appropriate and prudent 
generally acceptable commercial credit analysis processes and 
procedures consistent with those used for their similarly-sized, non-
SBA guaranteed commercial loans, and criteria that may be considered in 
lending criteria), will have a de minimis impact on the estimated hour 
burden because regulated lenders must comply with more rigorous lending 
criteria requirements from their federal regulators, and SBA-Supervised 
Lenders and CDCs must continue to comply with the credit policies 
submitted to OCRM.
    SBA will revise SBA Form 1920 to conform to revisions at 13 CFR 
120.130 and 13 CFR 120.202 to permit partial changes of ownership.
    SBA will revise SBA Form 1919, SBA Form 1920, SBA Form 1244, and 
SBA Form 5 to conform to the affiliation rule changes at 13 CFR 
121.301, which will reduce the estimated hour burden for applicants and 
lenders because SBA anticipates fewer entities will fall under the 
definition of ``affiliate.''
    SBA will submit these revisions to OMB and provide public notice of 
such revisions at a later date.

Congressional Review Act, 5 U.S.C. Ch. 8

    Subtitle E of the Small Business Regulatory Enforcement Fairness 
Act of 1996, also known as the Congressional Review Act or CRA, 
generally provides that before a rule may take effect, the agency 
promulgating the rule must submit a rule report, which includes a copy 
of the rule, to each House of the Congress and to the Comptroller 
General of the United States. SBA will submit a report containing this 
rule and other required information to the U.S. Senate, the U.S. House 
of Representatives, and the Comptroller General of the United States. A 
major rule under the CRA cannot take effect until 60 days after it is 
published in the Federal Register. The Office of Information and 
Regulatory Affairs has determined that this rule is not a ``major 
rule'' as defined by 5 U.S.C. 804(2). Therefore, this rule is not 
subject to the 60-day restriction.

Regulatory Flexibility Act, 5 U.S.C. 601-612

    When an agency issues a rulemaking proposal, the Regulatory 
Flexibility Act (RFA), 5 U.S.C. 601-612, requires the agency to 
``prepare and make available for public comment a final regulatory 
analysis'' which will ``describe the impact of the final rule on small 
entities.'' SBA published a complete regulatory analysis in the 
proposed rule. The regulatory analysis is synopsized here. For the 
reasons stated below, SBA certifies that this rulemaking will not have 
a significant economic impact on a substantial number of small 
entities. Although the rulemaking will impact all of the 2,897 7(a) 
Lenders, all of the 216 CDCs, all of the 150 Microloan Intermediaries, 
all of the 35 ILP Intermediaries, and all of the 44 Sureties that 
participate in the SBG Program, SBA does not believe the impact will be 
significant because this final rule modifies and streamlines existing 
regulations and procedures. However, there may be impacts due to 
increased 7(a) loans for partial changes of ownership.
    The estimated burden for completing the SBA Form 1919, including 
time for reviewing instructions, gathering data needed, and completing 
and reviewing the form remains unchanged at 15 minutes per response. 
SBA anticipates the revised rules will result in an increase to loan 
volume by a potential 800 loans per year \2\ representing 800 unique 
small business applicants.
---------------------------------------------------------------------------

    \2\ The 800 additional loans are due to the revisions allowing 
for partial changes of ownership.
---------------------------------------------------------------------------

    An applicant completing the SBA Form 1919 will spend approximately 
fifteen minutes per response in completing the form, at a cost of 
$23.55 per loan application.\3\ The final rules will not change the 
time costs of completing the revised SBA Form 1919 as the rule changes 
will not require the applicant small business to provide any additional 
responses in completing SBA Form 1919 other than those already 
required.
---------------------------------------------------------------------------

    \3\ This estimate was derived from using the median hourly rate 
for General and Operations Managers from the May 2021 Occupational 
Employment and Wage Statistics for the United States of $47.10 per 
hour, adding 100 percent for overhead and benefits, for a total 
hourly cost to complete SBA Form 1919 per applicant of $94.20 per 
hour. Data available at https://www.bls.gov/oes/current/oes_nat.htm#11-0000.
---------------------------------------------------------------------------

    In revising 13 CFR 120.130 and 120.202 to permit partial change of 
ownership, SBA will update the SBA Form 1920, ``Lender's Application 
for Loan Guaranty for all 7(a) Loan Programs'', in Section ``O'', to 
add a question for the 7(a) Lender to indicate that the change of 
ownership is a partial change of ownership, and to revise or combine 
the second bulleted question in Section O with the new partial 
ownership question. The current estimated burden for the 7(a) Lender in 
completing SBA Form 1920, including time for reviewing instructions, 
gathering data needed, and completing and reviewing the form is 25 
minutes per response. Section ``O'' of SBA Form 1920 is required to be 
completed in cases involving a change of ownership using the loan 
proceeds. SBA Form 1920 currently requires the 7(a) Lender to check an 
``N/A'' box if the loan does not finance a change of ownership and 
answer an additional six ``Yes'' or ``No'' questions about the 
circumstances for the change of ownership. It is anticipated the 
additional language will be similar in length to the existing questions 
of approximately 30 words per question, which should add approximately 
10 seconds per application to read and respond to the question by 
checking the yes or no box,\4\

[[Page 21085]]

which represents a cost increase to lenders of approximately 11 cents 
per application.\5\
---------------------------------------------------------------------------

    \4\ The average silent reading rate for adults in English is 238 
words per minute, based on an analysis of 190 studies with 18,573 
participants by Brysbaert, Marc (April 12, 2019) How many words do 
we read per minute? A review and meta-analysis of reading rate, page 
2, at https://psyarxiv.com/xynwg/.
    \5\ Based on the mean hourly wage of $38.74 per hour for Loan 
Officers as of May 2021 U.S. Bureau of Labor Statistics at https://www.bls.gov/oes/current/oes_nat.htm#13-0000.
---------------------------------------------------------------------------

13 CFR 120.150, ``What are SBA's lending criteria?''

    Based on industry feedback, SBA estimates SBA Lenders will save 
anywhere from zero to 2 hours per loan under the revision of 13 CFR 
120.150 to require that SBA Lenders must use appropriate and prudent 
generally acceptable commercial credit analysis processes and 
procedures consistent with those used for their similarly-sized, non-
SBA guaranteed commercial loans. The range in time saving is due to the 
size and complexity of the loan and federally regulated lenders 
continuing to underwrite loans in accordance with their own procedures. 
Based on the average of the most recent 3 fiscal years, each year the 
7(a) Loan Program approves 48,687 loans and the 504 Loan Program 
approves 7,631 loans, for a total of 56,318 loans approved per year. 
The mean hourly wage of a loan officer is $36.99 according to the May 
2020 U.S. Bureau of Labor Statistics. SBA estimates a cost saving 
ranging from $0 to $2,083,215 per year for SBA Lenders, calculated by 
multiplying 56,318 (total loans approved per year) by $36.99 (mean 
hourly wage of a loan officer). This revision will have no direct 
impact on applicants and possibly an indirect impact due to faster 
processing times that could lead to faster loan approval.
    SBA anticipates the final rule will allow SBA Lenders to use a 
credit scoring model will increase the number of small loans approved 
while generally decreasing the length of time required to process a 
loan. Not all lenders will use credit scoring, and those that do will 
limit credit scoring to small loans. SBA estimates lenders will save 
from 2 to 4 hours per loan when they elect to use a credit scoring 
model.

13 CFR 120.160, ``Loan Conditions''

    SBA estimates SBA Lenders will save anywhere from 0.25 to 6 hours 
per loan over the life of the loan under the revision of 13 CFR 120.160 
to eliminate the requirement for hazard insurance on loans $500,000 or 
less. The range in time saving is due to whether lenders require hazard 
insurance on similarly-sized non-SBA guaranteed loans in accordance 
with their own procedures. Lenders that do not require hazard insurance 
may save up to 6 hours over the life of the loan when including the 
time required to monitor whether the policy remains in place each year. 
Lenders that continue requiring insurance will experience a time 
savings by no longer documenting proof of insurance for SBA.

13 CFR 120.193, ``Reconsideration After Denial''

    The Director of the Office of Financial Assistance processes an 
average of 10 to 12 reconsideration requests for the 7(a) Loan Program 
and 28 to 41 reconsideration requests for the 504 Loan Program each 
year. Revising this rule will have a minimal impact on the overall 
portfolio; however, to the individual applicants that are impacted by 
reconsideration requests, a faster decision will allow the applicants 
to quickly move forward with financing with a positive decision or 
pursue other financing options with a negative decision.

Section 121.301, ``What size standards and affiliation principles are 
applicable to financial assistance programs?''

    The revisions to 13 CFR 121.301 will impact all of the 
approximately 1,738 7(a) Lenders and 186 CDCs that make an SBA loan 
annually (based on FY 2021 data), all of the approximately 150 
Microloan Intermediaries, all of the approximately 44 Sureties that 
participate in the SBG Program, and all of the applicants for each of 
these programs and SBA's Disaster programs. SBA's revisions to 
streamline its affiliation rules will increase the overall number of 
loans made while simultaneously reducing the time required to process 
each loan.

List of Subjects

13 CFR Part 120

    Loan programs--business, Community development, Reporting and 
recordkeeping requirements, Small businesses.

13 CFR Part 121

    Loan programs--business, Reporting and recordkeeping requirements, 
Small businesses.

    For the reasons stated in the preamble, SBA is amending 13 CFR 
parts 120 and 121 as follows:

PART 120--BUSINESS LOANS

0
1. The authority citation for 13 CFR part 120 continues to read as 
follows:

    Authority: 15 U.S.C. 634(b)(6), (b)(7), (b)(14), (h), and note, 
636(a), (h) and (m), and note, 636m, 650, 657t, and note, 657u, and 
note, 687(f), 696(3), and (7), and note, and 697, 697a and e, and 
note; Public Law 116-260, 134 Stat. 1182.

0
2. Amend Sec.  120.130 by revising paragraphs (a) and (g) to read as 
follows:


Sec.  120.130  Restrictions on uses of proceeds.

* * * * *
    (a) Payments, distributions, or loans to Associates of the 
applicant (except for ordinary compensation for services rendered or to 
facilitate changes of ownership in accordance with Sec.  120.202);
* * * * *
    (g) Any use restricted by Sec. Sec.  120.201 and 120.884 (specific 
to 7(a) loans and 504 loans respectively).

0
3. Revise Sec.  120.150 to read as follows:


Sec.  120.150  What are SBA's lending criteria?

    The applicant (including an Operating Company) must be 
creditworthy. Loans must be so sound as to reasonably assure repayment. 
Lenders and CDCs must use appropriate and prudent generally acceptable 
commercial credit analysis processes and procedures consistent with 
those used for their similarly-sized, non-SBA guaranteed commercial 
loans. Lenders, CDCs, and SBA may use a business credit scoring model. 
When approving direct or guaranteed loans, Lenders, CDCs, and SBA may 
consider (as applicable) the following criteria: 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 where applicable any equity or collateral of the 
applicant.


Sec.  120.160  [Amended]

0
4. In Sec.  120.160 amend paragraph (c) by adding the phrase ``for 7(a) 
loans greater than $500,000 and for 504 projects greater than 
$500,000,'' after the words ``SBA requires hazard insurance.''

0
5. Amend Sec.  120.193 by adding the words ``or designee(s),'' after 
the words ``Director, Office of Financial Assistance (D/FA)'' and by 
adding two sentences at the end of the section to read as follows:


Sec.  120.193  Reconsideration after denial.

    * * * If the reconsideration is denied, a second and final 
reconsideration may be considered by the Director, Office of Financial 
Assistance (D/FA) or designee(s), whose decision is final. The SBA 
Administrator, solely within the Administrator's discretion, may choose 
to review the matter and make the final decision. Such discretionary 
authority of the Administrator does not create additional rights of 
appeal on the part

[[Page 21086]]

of an applicant not otherwise specified in SBA regulations.

0
6. Revise Sec.  120.202 to read as follows:


Sec.  120.202  Loans for changes of ownership.

    A Borrower may use 7(a) loan proceeds to purchase a portion of or 
the entirety of an owner's interest in a business, or a portion of or 
the entirety of a business itself.

PART 121--SMALL BUSINESS SIZE REGULATIONS

0
7. The authority citation for 13 CFR part 121 is revised to read as 
follows:

    Authority: 15 U.S.C. 632, 634(b)(6), 636(a)(36), 662, 694a(9), 
and 9012.


0
8. Amend Sec.  121.301 by adding introductory text and by revising 
paragraph (f) to read as follows:


Sec.  121.301  What size standards and affiliation principles are 
applicable to financial assistance programs?

    The Small Business Act defines a small business concern 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.
* * * * *
    (f) Affiliation. Any of the circumstances described below 
establishes affiliation for applicants of SBA's Business Loan, Disaster 
Loan, and Surety Bond Programs. For this rule, the Business Loan 
Programs consist of the 7(a) Loan Program (Direct and Guaranteed 
Loans), the Microloan Program, the Intermediary Lending Pilot Program, 
and the Development Company Loan Program (``504 Loan Program''). The 
Disaster Loan Programs consist of Physical Disaster Business Loans, 
Economic Injury Disaster Loans, Military Reservist Economic Injury 
Disaster Loans, and Immediate Disaster Assistance Program loans. The 
following principles apply for the Business Loan, Disaster Loan, and 
Surety Bond Guarantee Programs:
    (1) Ownership. (i) When the Applicant owns more than 50 percent of 
another business, the Applicant and the other business are affiliated.
    (ii) When a business owns more than 50 percent of an Applicant, the 
business that owns the Applicant is affiliated with the Applicant. 
Additionally, if the business entity owner that owns more than 50 
percent of the Applicant also owns more than 50 percent of another 
business that operates in the same 3-digit NAICS subsector as the 
Applicant, then the business entity owner, the other business and the 
Applicant are all affiliated.
    (iii) When an individual owns more than 50 percent of the Applicant 
and the individual also owns more than 50 percent of another business 
entity that operates in the same 3-digit NAICS subsector as the 
Applicant, the Applicant and the individual owner's other business 
entity are affiliated.
    (iv) When the Applicant does not have an owner that owns more than 
50 percent of the Applicant, if an owner of 20 percent or more of the 
Applicant is a business that operates in the same 3-digit NAICS 
subsector as the Applicant, the Applicant and the owner are affiliated.
    (v) When the Applicant does not have an owner that owns more than 
50 percent of the Applicant, if an owner of 20 percent or more of the 
Applicant also owns more than 50 percent of another business entity 
that operates in the same 3-digit NAICS subsector as the Applicant, the 
Applicant and the owner's other business entity are affiliated.
    (vi) Ownership interests of spouses and minor children must be 
combined when determining amount of ownership interest.
    (vii) When determining the percentage of ownership that an 
individual owns in a business, SBA considers the pro rata ownership of 
entities. For example, John Smith, Jane Doe, and Jane Doe, Inc., each 
own an interest in the Applicant. Jane Doe owns 15 percent of the 
Applicant, and she also owns 100 percent of Jane Doe, Inc. Jane Doe, 
Inc. owns 50 percent of the Applicant. SBA considers Jane Doe to own 65 
percent of the Applicant.
    (2) Stock options, convertible securities, and agreements to merge. 
(i) For purposes of this subparagraph, SBA considers stock options, 
convertible securities, and agreements to merge (including agreements 
in principle) to have a present effect on the ownership of the entity. 
SBA treats such options, convertible securities, and agreements as 
though the rights granted have been exercised.
    (ii) Agreements to open or continue negotiations towards the 
possibility of a merger or a sale of stock at a later date are not 
considered ``agreements in principle'' and are thus not given present 
effect.
    (iii) Options, convertible securities, and agreements that are 
subject to conditions precedent which are incapable of fulfillment, 
speculative, conjectural, or unenforceable under state or Federal law, 
or where the probability of the transaction (or exercise of the rights) 
occurring is shown to be extremely remote, are not given present 
effect.
    (iv) SBA will not give present effect to individuals', concerns', 
or other entities' ability to divest all or part of their ownership 
interest to avoid a finding of affiliation.
    (3) Determining the concern's size. In determining the concern's 
size, SBA counts the receipts, employees (see Sec.  121.201), or the 
alternate size standard (if applicable) of the concern whose size is at 
issue and all of its domestic and foreign affiliates, regardless of 
whether the affiliates are organized for profit.
    (4) Exceptions to affiliation. For exceptions to affiliation, see 
Sec.  121.103(b).
* * * * *

Isabella Casillas Guzman,
Administrator.
[FR Doc. 2023-07173 Filed 4-7-23; 8:45 am]
BILLING CODE 8026-03-P