Cumulative Preferred Dividends with SBA Loans

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by an investor from Michigan State University - The Eli Broad College of Business
in Farmington Hills, MI, USA

11mos ago

Cumulative Preferred Dividends with SBA Loans

I have heard from a lender they are interpreting preferred equity with cumulative dividends as being considered debt, based on the update SOPredactedfrom the SBA. Assuming other institutions are interpreting it this way, how are people making adjustments to how they structure dividends for preferred stock? This appears to be the only section from the SOP which references it: g) An equity investment not subject to an agreement to repay equity or make distributions to recover an investor’s investment prior to release of the guaranty. Note: Whether called “search funding” or by some other name, SBA will consider any investment subject to an agreement to repay equity or make distributions to recover an investor’s investment prior to release of the guaranty (e.g., certain types of redeemable preferred stock) to be debt and not equity.

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reply by a professional 11mos ago
from University of Michigan in Detroit, MI, USA

I agree. The bank gets paid before preferred returns are distributed. I can't see how this makes a difference to the lender unless there is some mechanism that requires a payoff (as oppose to an incentive).

reply by an investor 11mos ago
from New York University in New York, NY, USA

Agree with ^redacted‌ and ^redacted‌. I recently invested in a deal under the new SOP that had the same pref structure as I had invested in under the old SOP. I am involved with another deal that is currently in underwriting with another bank that has the same structure and so far there has been no pushback on this. Other folks might be using different structures that mandate a pref dividend owed by the company and that accrues on the company’s books, but the classic “self funded search” structure based on a pref return still works. The pref return is not a company obligation and is not accrued on the books - it is solely used to determine how distributions are split between the pref and common investors. It is effectively a distribution waterfall. Once the pref return and pref capital have been distributed to the pref investors, distributions after that are split X% to the pref and Y% to the common (based on the step-up). If the searcher does not want to make distributions until exit, they are not obligated to do so.