In the past, FSA had a requirement that all entity applicants had to be owned by individuals. Again, the FSA’s goal was to avoid financing large, complex corporate operations. However, over time, business practices for small businesses have changed. Family/small operations have begun to segregate aspects of their businesses for liability, financial planning, and succession purposes. In response, the FSA has changed its rule and now allows a certain composition of entity owners for an entity applicant for a FO loan.
When an entity applicant has an owner that is also an entity, FSA calls these ‘embedded entities.’ To curtail embedded entities hiding away investor-only owners, the FSA developed the 75% embedded entity rule.
Suppose any entity applicant has one or more embedded entities. In that case, at least 75% of the individual ownership interests of each embedded entity must be owned by members actively involved in managing or operating the farm that complies with the family farm requirements.
For example, let’s consider a business entity that wants to apply for an FSA FO loan. One owner of this entity was an individual with the requisite managerial ability, creditworthiness, and other necessary criteria for the loan. This individual owned a 50% interest and will be the field operations manager once the farm gets up and running. The other owner was a separate business that owned and operated all the equipment for the farm, and that entity (the “equipment entity”) also held 50% ownership in the entity applicant.
In this case, FSA would look into the entity applicant as to whether it met all the criteria we have discussed in this guide. At the same time, FSA would also look into the equipment entity that owns 50% of the entity applicant. Ownership of that second entity–the equipment entity–must be made up of individuals who will be actively involved in managing and operating the farm that is applying for the FO loan. If the equipment entity has one owner with 100% ownership, the owner must have managerial authority in the entity applicant business and be actively involved in its operation. For example, the owner of the equipment entity might be responsible for the care, maintenance, and operational decisions of the equipment for the farming operation. That arrangement would likely satisfy this requirement.
However, if the equipment entity was owned by someone who invested in the equipment for the entity applicant but had no involvement in the farm operation itself, then that embedded entity wouldn’t pass the 75% test, and the entity application would be ineligible for an FSA FO loan.