An eligible passive company is an entity that owns real estate, or other assets, and leases them to an operating company that uses them in its business. SBA generally does not lend to passive businesses, but an EPC can borrow under a 7(a) or 504 loan if it leases the property to an eligible operating company, the operating company joins the loan as co-borrower or guarantor, and every owner of 20% or more of either company guarantees. The structure is common because owners want the building held apart from the business's liabilities.
- What it is
- A holding entity that owns property and leases it to the operating business
- Why it is allowed
- An exception to SBA's rule against lending to passive businesses
- Operating company's role
- Co-borrower, or at least guarantor; co-borrower if it uses proceeds
- Guarantees
- Every owner of 20% or more of either company
- Occupancy
- At least 51% of an existing building, or 60% of new construction
Two companies, one loan
A common way to own a business's premises is to split them from the business. The owners form one company, often a limited liability company, to hold the building. The operating business, which makes the sales and employs the staff, leases the building from it. The holding company collects rent and pays the mortgage; the operating company pays rent as an expense.
SBA's rules in SOP 50 10 generally make passive businesses ineligible: SBA guarantees loans to operating businesses, not to landlords. The eligible passive company rule is the exception. A holding company that leases its property to an eligible operating company, usually called the OC, can be the borrower on an SBA loan to buy, build or improve that property, provided both companies meet the conditions below.
| Party | What it does | What it signs |
|---|---|---|
| Eligible passive company (EPC) | Holds title to the property and leases it to the OC | The note, the mortgage and an assignment of the lease and rents |
| Operating company (OC) | Runs the business and occupies the property | The note as co-borrower, or a guarantee |
| Owners of 20% or more of the EPC | Own the property through the EPC | Personal guarantees |
| Owners of 20% or more of the OC | Own the business | Personal guarantees |
The conditions SBA sets
The EPC rules exist so that the loan really serves the operating business. Each condition closes a way the structure could be used to finance something else.
- Use of proceeds. The EPC may use its loan proceeds only to acquire, build, improve or renovate property that it leases to the OC. It cannot use them as working capital for itself or to buy property for other tenants.
- Both companies eligible. The OC must be an eligible business in its own right, and the two are affiliates, so SBA's size standard is applied to them together. See SBA affiliation rules.
- The OC joins the loan. The OC must be a co-borrower or at least a guarantor. If any of the proceeds go to the OC itself, for working capital or equipment, it must be a co-borrower.
- A written lease. The EPC and OC sign a lease whose term, with renewal options, runs at least as long as the loan. The lease is subordinated to the lender, and the EPC assigns the rents to the lender as collateral.
- Occupancy. The OC must occupy at least 51% of an existing building, or 60% of new construction. The EPC may lease the rest to outside tenants.
- Guarantees. Every owner of 20% or more of either company personally guarantees the loan. See who has to guarantee an SBA loan.
Lenders also read the lease terms for the rent. Rent that roughly covers the EPC's loan payment and the building's costs is ordinary. Rent set well above that moves cash out of the company that is repaying the loan, and a lender will ask why.
Why owners use the structure
The EPC structure is common in owner-occupied real estate deals for reasons that have little to do with SBA:
- Liability. A claim against the operating business does not reach a building held in a separate company as easily.
- Sale flexibility. The owners can sell the business and keep the building, leasing it to the buyer. See buying the building vs leasing it from the seller.
- Family and estate planning. The building can be owned in different proportions from the business, for example with children who are not in the business.
- Tax. Owners' tax advisers often prefer holding property separately; how the rent and depreciation fall is a matter for them, not the lender.
The structure does not shelter the owners from the loan itself. The EPC and OC are both on the hook, and so is every guarantor. A lender treats the pair as one credit.
How lenders underwrite an EPC and its operating company
Because the rent is a payment from one company to the other, a lender does not count it as income to the group. It combines the two, eliminates the rent and measures the cash flow of the whole against all the debt service: the EPC's mortgage and any debt of the OC. The owners' personal cash flow is then added in a global cash flow analysis.
A worked illustration in plain numbers. The OC earns 1,300 before rent and pays rent of 300 to the EPC, which pays 250 a year on its SBA loan. Looked at separately, the EPC covers its payment with rent of 300 against 250, and the OC earns 1,000 after rent. Combined, the lender sees 1,300 of cash flow against the EPC's 250 plus whatever debt the OC carries. SBA requires debt service coverage of at least 1.15x, and 1.0x globally including the owners; the combined view is what that test is applied to.
An EPC's strength is the tenant. If the operating company cannot pay rent, the building company cannot pay the loan.
EPCs in acquisitions and 504 loans
The structure appears most often in three kinds of deals, and each one uses it differently.
| Deal | How the EPC is used | Points to watch |
|---|---|---|
| Buying a business and its building | The buyer forms a new OC to buy the business and a new EPC to buy the building, often under one 7(a) loan with both as co-borrowers | The 7(a) limit of $5 million covers both companies together; real estate can amortize over up to 25 years |
| Buying the building with a 504 loan | The EPC is the 504 borrower; the OC is co-borrower or guarantor | Typically 50% bank, 40% CDC and 10% borrower; 15% for a new business or special-purpose property, 20% for both |
| Buying a building for an existing business | Existing owners form an EPC to hold it, and the business signs a new lease | Occupancy tests and a lease at least as long as the loan |
In an acquisition, a 504 loan for the building paired with a 7(a) loan for the business is a common split, because the real estate goes on long-term financing and the goodwill on the 7(a). See financing an acquisition that includes the real estate, SBA 7(a) vs 504 and how the maturity is set on mixed uses. From 1 October 2026, change-of-ownership loans amortize over no more than 10 years except the real estate share, so the split between business and building matters more to the payment than before.
Getting the paperwork right
An EPC file carries two companies' paperwork. The lender will need the EPC's formation documents and ownership, the OC's, the signed lease with its term and rent, and each company's financial statements. Where the EPC already owns the building and is refinancing, it will need the existing mortgage and a payoff letter; SBA's refinancing rules apply: a 7(a) refinance needs a new payment at least 10% lower and the debt current for the last 12 months, and a 504 refinance has its own conditions. See refinancing owner-occupied real estate with a 504.
Transparent's lender book holds 278 lenders that write SBA 7(a) and 504 loans, and not all of them are equally comfortable with two-company structures or outside tenants. The lender package, financing model, lender presentation, blind teaser and underwriting memo, is built in a day once the documents are in and presents the EPC and OC as the single credit a lender will underwrite. On SBA loans the lender pays Transparent, not the borrower.
Common questions
- Does the building have to be in a separate company to get an SBA loan?
- No. The operating company can own and borrow for the building directly. The EPC route is an option owners choose for liability, estate or sale reasons, and SBA accommodates it.
- Can the EPC lease part of the building to other tenants?
- Yes, within the occupancy rules. The operating company must occupy at least 51% of an existing building, or 60% of new construction, and the rest may be leased out.
- Do owners of the EPC who are not in the business have to guarantee?
- If they own 20% or more of the EPC, yes. SBA's guarantee rule applies to owners of each company, whether or not they work in the business.
- Can an EPC borrow for working capital?
- No. The EPC's proceeds are limited to property it leases to the operating company. Working capital goes to the operating company, which then must be a co-borrower.
- Are the EPC and operating company one borrower for SBA's loan limit?
- They are affiliates, so SBA's limits apply to them together: 7(a) loans go up to $5 million and SBA's guaranty to one borrower is capped at $3.75 million.