You and your business partner have enjoyed a long and prosperous time running the joint business. There may come a time when they want to exit this partnership. This could be due to several reasons. Perhaps they just want to cash out and retire or they might be moving someplace else.
They could also be thinking about doing their own thing and plan on using the funds from the buyout as startup capital. There may also be instances where you feel that your vision for the business doesn’t align with your partner’s. In that case, it would be better for the business to buy them out.
Partner buyout financing can be difficult to come by through conventional means. The process tends to be complex, and the terms can often dissuade business owners from pursuing this avenue.
With that being said, an equity buyout loan remains one of the best options to say farewell to a partner since for the vast majority of business owners, it’s next to impossible to put up that much money from their own pocket.
This is precisely what makes SBA partner buyout loans so attractive. SBA 7(a) loans can be used for partner buyout financing. The maximum permitted loan under this program is $5 million of which up to 75% may be guaranteed by the SBA.
It wasn’t always that easy, though. A rule change in 2018 has made it far easier for business owners to obtain an SBA loan for the express purpose of buying out a partner.
How SBA Partner Buyout Loans Were Simplified in 2018
The Small Business Administration tweaked its rules to make it easier to obtain financing for buying out a partner. Before this change, getting an SBA partner buyout loan was essentially impossible. That’s because the process would normally leave businesses with negative equity, thus forcing a large cash injection into the company, an option that not many could afford.
The new rules introduced by the SBA in 2018 stated that the borrower didn’t need to put down any equity provided that the business had a debt-to-net-worth ratio below 9:1. If the ratio is greater, the borrower now must contribute 10% equity in order to qualify for the loan.
How To Calculate The Debt-To-Net-Worth Ratio
There’s a simple formula that you can use to calculate this ratio for your business. It requires the total liabilities to be divided by the total equity.
Assets: $20,00,000
Debt: $750,000
Equity: $1,250,000
Debt-to-net-worth ratio: 0.6
Based on this example, the required ratio is below nine to one, thus eliminating the need for the borrower to inject equity. The borrower can leverage the equity of the balance sheet instead.
Partners Must Agree on Business Valuation
A partner’s share is directly tied to the valuation of the business. The higher the valuation, the more they stand to make when they sell their shares. Naturally, there are often conflicting views on the valuation which can make the equity buyout process tedious.
Before the buyout can proceed, the partners must agree on the valuation. Otherwise, it would be impossible to figure out how much the exiting partner needs to be paid. This has the potential of stalling the sale and thus negatively impacting the future of the business.
The simplest way is for each partner to share what they think the company is worth. If the numbers are significantly different, they can hire a third-party valuation expert to get more precise information about how much their business is worth.
Restrictions On SBA Partner Buyout Loans
If you’re thinking about getting an SBA loan for partnership buyout, do keep in mind that the borrower will be required to provide a detailed business plan. This plan needs to demonstrate how the business stands to benefit from the buyout transaction.
That’s because some lenders might be apprehensive about the future of the business, particularly if they feel that a partner’s absence could negatively affect it. Borrowers thus have to prove that they can run the business themselves effectively.
Remember, it’s not the Small Business Administration that’s making these loans. It only guarantees the loans that are disbursed by banks and other lenders under the SBA’s various programs.
SBA loans can’t be used to finance partial buyouts. The borrower needs to acquire the entire share, this also applies to existing partners that are buying out other partners in the business. The seller isn’t allowed to be involved with the company after the transaction in any capacity as an owner, officer, director, or employee.
If a transitional period is required after the sale, the seller may be hired as a paid consultant for a maximum period of up to 12 months. They can’t continue even as a paid consultant after the 12 months are up.
Different Ways to Buy Out Your Partner
Business owners can rely on different ways to buy out their partner, however, not all of them are allowed under the rules for SBA partner buyout loans. These are the most common ways to buy out your partner with an SBA 7(a) loan.
- Lump-sum buyout: This is the fastest and easiest method of buying out a partner but it’s also the most expensive. It requires you to provide the partner with a one-time all cash payment in exchange for their equity in the business.
- Buyouts over time: The partner being bought out still leaves the business immediately, but they are paid through a series of installments over time, the specifics of which are decided mutually when the transaction is finalized.
The Best Banks for SBA Partner Buyout Loans
Here at SBALenders.com, we work hard to help businesses access the financing that they need to thrive. Our partners have disbursed SBA partner buyout loans to businesses in all industries across the country.
Get in touch with us today and we’ll work with you to find the perfect local or nationwide lender to have you in complete control of your business.