Consider an SBA Loan when you are ready to buy out your partner
By: Jim Frey, Senior Vice President – Business Development Officer at Gulf Coast Small Business Lending
The Small Business Administration’s 7(a) loan program, commonly known as the SBA 7(a) loan program, is a versatile financial tool that can be used for various purposes, including partner buyouts. A partner buyout occurs when one or more existing owners acquire the entire interest of another owner, leading to a change in the business’s ownership structure. This article will provide some useful information if you are considering utilizing an SBA loan to finance a partner buyout. For the purposes of this article, an “SBA loan” refers to a loan provided using the SBA 7(a) loan program.
To start, the requirements for an SBA loan to buy out a partner stipulate that the business must have a debt-to-net-worth ratio of 9:1 or less. If the ratio is larger than this, the borrower will need to put 10% down to qualify for the loan. If you need assistance determining your business’s debt-to-net-worth ratio, please speak with your SBA lender or your accountant/CPA.
As an example, let’s consider a business with assets valued at $6,000,000, debt/liabilities of $3,100,000, and equity of $3,920,000. The debt-to-net worth ratio in this scenario is 0.79, which is below the threshold of 9:1, eliminating the need for an equity injection (also known as “down payment”, using personal cash reserves).
One of the many advantages of using an SBA loan for a partner buyout is the long-term repayment schedule that is available. Loan payments are calculated based on a 10-year fully amortizing loan repayment term which typically results in a manageable monthly loan payment. This 10-year loan term distinguishes SBA loans from traditional commercial loans which typically offer only five- to seven-year terms.
Another advantage of using an SBA loan for a partner buyout is that they are available with no collateral requirements in amounts of up to $5 million.
To help illustrate the use of an SBA loan in a partner buyout, let’s consider a scenario where one partner wishes to purchase another’s stake. Regardless of whether the contemplated transaction is a full or partial buyout, an SBA loan makes this feasible.
Let’s review the details and typical terms:
A partial change of ownership involves the sale of a portion, but not all, of a selling owner’s interest. In contrast to complete buyouts, only the remaining owners who hold 20% or more of the business (based on ownership post-sale) are required to personally guaranty the loan.
A complete partner buyout occurs when one or more existing owners acquire the entire interest of another owner, resulting in 100% ownership for the remaining owner(s). In this scenario, the acquiring owner(s) and the business entity act as co-borrowers. Typically, in an SBA loan, only owners with a 20% or more ownership stake are required to personally guaranty the loan, but in a complete partner buyout, all remaining owners, irrespective of their ownership percentage, must jointly and severally guaranty the loan.
A borrower can be eligible for an SBA loan without the need for an equity injection (also known as “down payment”, using personal cash reserves), provided that two conditions are met:
- The business’s debt-to-net-worth ratio is at or below 9:1 at the end of the year and the most recent period, and
- The purchasing partner has been actively involved and has maintained the same or a higher ownership percentage for over two years.
In the event of a full 100% buyout, a short-term consulting agreement can be set up, allowing the seller(s) to provide support and assistance for a period not exceeding 12 months. Often this helps ease the transition to the new owners and helps the seller ease into retirement or their next venture. As you can imagine, a buyout with complete change of ownership has the potential to be disruptive for employees, vendors, and customers. Keeping the seller(s) involved for several months, even if only on a limited basis, can help smooth things out for all involved.
Another matter to consider in a partner buyout is the need for a business valuation. In my experience, determining a fair value for the share(s) can sometimes lead to disagreements between the buying and selling partners. To address this, the SBA mandates an independent third-party valuation of the business. This third-party valuation provides valuable data and information that both buyer(s) and seller(s) will need as they negotiate and finalize their buyout.
There are some other key points and features that you’ll want to know about if you use an SBA loan for your partner buyout:
- The maximum term for partner buyout loans is 10 years, fully amortizing;
- Prior to May 2023, borrowers were required to acquire all of a business (100%), there was no option for a partial buyout. This was often an obstacle for many borrowers and prevented many from proceeding with an SBA loan. To address this situation, the SBA listened to lenders and borrowers and ultimately relaxed the rules, allowing existing business owners to buyout the equity interests of other partners, either completely or partially;
- It is important that you work with an experienced SBA lender as you will want someone to guide you through the process who is up to date on all of the current SBA requirements. In addition, it is helpful if your SBA lender is a designated SBA Preferred Lender. For more information about choosing the right SBA lender for your project, I recommend you check out this detailed article on our website: How to Choose the Right SBA Lender for Your Project (A few things to consider when selecting which SBA lender is best for you).
I often find it helpful to share real-life examples so let’s look at one involving a home health care business with two partners who each owned 50%. One partner, in his late sixties, wished to retire, while the other partner, in her early fifties, wanted to continue working and running the business. After negotiating the price, the younger partner secured an SBA loan to buyout the other partner. The debt-to-equity ratio was acceptable, and the cash flow was robust. A third-party business valuation confirmed the accuracy of the purchase price. The SBA loan facilitated 100% financing, enabling the older partner to retire. The remaining partner now owns the entire business!
If you have any other questions, I am always happy to talk with prospective borrowers. In addition, you can find additional information about many of the industries and loan purposes offered by Gulf Coast Small Business Lending by visiting the SBA Loans section of our website.
Jim Frey has over 21 years of financial services experience, including an exclusive focus on SBA lending since 2012. Jim enjoys working with many referral sources across the US and he takes particular satisfaction in helping business owners reach their goals through SBA financing. Over the years, Jim has developed a specific expertise in structuring SBA loans for business acquisitions, franchise lending, expansions and construction. Jim has a Master of Business Administration from the University of Pittsburgh’s Katz Graduate School of Business and a B.S. in Finance from St. Vincent College. When not working on deals, Jim’s hobbies include hiking, volunteering, golfing, and traveling with his wife and two daughters.
Products and services offered by Gulf Coast Small Business Lending, a division of Gulf Coast Bank & Trust Co. Nothing herein shall be construed as a commitment to lend. All loans are subject to credit and collateral approval. Additional terms, restrictions and limitations may apply. Loans are only available to U.S. citizens and residents. Member FDIC – Equal Housing Lender.