U.S. Small Business Administration (SBA) underwriting requirements for a 504 Loan include instructions to identify if there is a “key man” or “key person” to the applicant’s operations. This would be a person, who if they should pass away, would affect the business’ ability to continue and repay the SBA loan. If a company has such a person, the SBA requires a collateral assignment of life insurance on the life of the business owner as additional collateral for the loan. This requirement can be overcome if a business can show that someone else is capable of successfully managing the business. This is usually formalized by a written transition plan. Key person life insurance may also not be necessary if there is sufficient collateral to repay the loan.
When life insurance is required, the SBA does not require a particular type of insurance, term or whole life. The policy must be maintained for the term of the loan, unless the life insurance requirement is later amended by the SBA. The amount of life insurance required will never be more than the original amount of the loan, and in some cases it can be less, depending on the value of other collateral.
Prior to closing the 504 loan, Alloy will obtain a collateral assignment of the life insurance policy, naming Alloy/SBA as the assigned. This assignment must be properly acknowledged by the home office of the life insurance company. If the key person dies, Alloy/SBA has the right to collect the life insurance proceeds. Depending on circumstances, Alloy/SBA may elect to pay off the balance of the 504 loan, pay down the Third-Party Lender loan (thereby improving the 504 loan collateral position), or allow the proceeds to be used by the business. Which option is used depends on if the SBA determines that new management has the ability to run the day-to-day operations of the business.
When insurance is required, it is important that the key person start the assignment process soon after the SBA Loan Authorization is issued, as it may take a minimum of 45 to 60 days to receive the acknowledged collateral assignment from the home office of the life insurance company. If a new life insurance policy is needed by the key person, several life insurance companies have created specific programs to expedite the application and approval processes for SBA loans. Please contact Alloy at 513-631-8292 or at lending-info@alloydev.org for more information on these offerings.
