When someone asks me about financing a partner buyout, I usually ask how they arrived at the price. Not because I want to negotiate it for them – I don’t, but because the price tells me what kind of problem we’re trying to solve.
Let’s say you and your partner agree that their share is worth $1 million. That still leaves several questions. Do they want all the money when they leave? How much cash can you put into the purchase? And how much can the business pay each month without turning every slow week into a concern about meeting debt obligations?
These are the questions that will tell us whether an SBA loan makes sense, or whether you should look at a conventional loan, a seller note, or some combination.
With an SBA loan, you can pay your partner now
An SBA 7(a) loan can be used to finance a qualifying purchase of a partner’s interest. The program allows partial changes of ownership and loans of up to $5 million. SBA 7(a) term loans are repaid with monthly principal-and-interest payments from the business’s cash flow.
The obvious advantage is that your partner will receive their payout right at closing instead of you sending them a check every month for the next several years. If what both of you want is a clean separation, this works out perfectly.
Under this scenario, you’re sending the lender a check every month. So as a lender, I’d want to know whether the company can afford it, particularly if your partner had been doing work you’ll now need to hire someone else to do.
As I’ve said before, in an acquisition, the question we ask is: how much debt can it take on? A partner buyout is no different. While we can’t decide what you should pay to buy out your partner, we can tell you how much borrowing the business appears to be able to support.
There are SBA requirements to satisfy as well. The lender must assess repayment ability and apply the change of ownership requirements that fit the transaction, including any applicable equity and liquidity conditions. So, I’d bring a lender into the conversation before the price, the payment terms, and the closing date are all set in stone.
Asking the seller to finance part of the deal
Sometimes the numbers are close, but not close enough. Your partner agrees to a price of $1 million, for example, and the bank is comfortable lending less than you need. If the departing partner is willing to accept part of the price over time, a seller note may help close that gap. Seller financing can be used alongside a business loan in a buyout.
I’d ask both partners to be honest about whether they want that arrangement. Some people have an easy working relationship and are happy to keep a financial connection. Others have spent months trying to untangle one. A seller note is going to keep them in each other’s lives, at least as long as the term of the seller note.
A seller note creates another claim on the business’s cash. Consider what you would owe the lender and the seller each month, then see what remains. Also realize that the lender will need to review the terms of the seller note to confirm that it aligns with all SBA requirements.
What about a regular (conventional) bank loan?
I would absolutely consider this option. If a conventional bank will make the loan on reasonable terms, put its offer next to an SBA proposal. Compare how much money you need at closing and what the payments will be. Those figures affect the business more than the name of the loan program.
We specialize in SBA lending at Gulf Coast Small Business Lending, including business acquisitions and partner buyouts. That doesn’t mean I think an SBA loan wins every comparison. However, after years of comparing options, I find that an SBA loan most often provides the most favorable combination of terms.
Using cash or bringing in an investor
If you can pay with your own cash, you may not need a loan at all. If you go down this path, it is still important to understand how much cash (also known as liquidity) you’ll have left in the bank. Buying your partner’s share could be followed by a new hire, a costly repair, or a stretch of weak sales. Money in the bank gives you options when cash outlays are required or when unexpected things happen.
An investor can provide some of the purchase money without adding a loan payment. Of course, you’ll be sharing ownership again. That may be exactly what you want with the right person; it’s worth thinking about if your reason for the buyout is that you’d rather make decisions alone. Alternative lenders are another possibility when bank financing isn’t suitable, though you need to understand the full repayment obligation before signing.
Our team is always happy to talk about the merits of an SBA loan in your specific situation. To get started, we will need information about what your partner expects to receive, the business cash flow, and what it will cost to operate the business after they leave. Then we can work out whether the loan fits or whether the deal needs a different mix of funding sources. You may just discover that an SBA 7(a) loan is the ideal fit for your situation.