Partner buyouts are transformative events in the life of a business, reshaping its ownership structure and paving the way for new opportunities. Whether you’re considering a complete partner buyout or a partial change of ownership, understanding the financing requirements and options is crucial for a successful transition. In this article, we will explore the intricacies of partner buyouts, including the financing requirements for complete and partial changes, the involvement of the seller during the transitional period, and the various options available to ensure a smooth transition.
Complete Partner Buyout
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 a complete partner buyout, the acquiring individual(s) and the small business must act as co-borrowers, jointly and severally executing the loan agreement.
Typically, in an SBA loan, only owners with 20% or more ownership stake are required to personally guarantee the loan. However, in a complete partner buyout, all remaining owners, regardless of their ownership percentage, must jointly and severally guarantee the loan. This means that even a 1% owner would be obligated to provide a personal guarantee for the entire SBA loan amount. It may be challenging to obtain the personal guarantee from a minority owner who may be hesitant to take on such substantial financial responsibility.
Partial Changes of Ownership: Flexibility in Financing
In some cases, a business may undergo a partial change of ownership, where a portion but not all of a selling owner’s interest is sold. Similar to complete buyouts, both the small business and the acquiring individual(s) must act as co-borrowers. However, unlike complete buyouts, only remaining owners owning 20% or more of the business based on their post-sale ownership percentages are required to personal guarantee the SBA loan.
Transitional Period and Seller Involvement
For complete buyouts, a short-term consulting agreement can be established allowing the seller(s) to offer support and assistance for a period not to exceed 12 months. For partial owner buyouts, sellers may choose to remain as owners, officers, directors, stockholders, key employees, or consultants within the business.
Valuing the business
Valuing a partner’s share in a business is a critical step in the equity buyout process, as it directly impacts the financial outcome for both parties involved. However, differing views on valuation can often make this process challenging.
Before proceeding with the buyout, partners must reach a consensus on the valuation. Without a clear understanding of the business’s worth, it becomes impossible to determine the appropriate payment for the exiting partner. To ensure a fair and objective assessment, the SBA requires an independent third-party valuation to be conducted on the business. In many cases, buyers and sellers will agree to rely on the findings of this independent valuation report to establish the value. While parties have the flexibility to agree on a sale at a lower valuation than what the independent valuator calculated, it’s important to note that the SBA loan cannot exceed the determined value. This limitation ensures that the loan aligns with the realistic value of the business, and the SBA lender is financing an asset – the ownership in the business.
The simplest approach for determining the value is for each partner to share their own assessment of the company’s worth. If there is a significant discrepancy in their estimations, engaging a third-party valuation expert can provide more precise and unbiased insights into the business’s actual value. We encourage parties to a buyout transaction to have an open and transparent discussions about valuation before engaging an SBA lender or third-party business valuation firm to ensure there is not valuation disconnect that would keep the parties from proceeding with the sale.
Buyer’s equity injection and debt-to-net-worth ratio
Frequently, a buyer may obtain 100% financing for a partner buyout loan. In 2018, the SBA introduced new rules aimed at facilitating partner buyout loans. According to these rules, borrowers no longer need to provide any upfront equity if their business maintains a debt-to-net-worth ratio below 9:1. However, if the ratio exceeds this threshold, borrowers must contribute a 10% equity stake to qualify for the loan.
To calculate the debt-to-net-worth ratio for your business, you can employ a simple formula: divide the total liabilities by the total equity. Let’s consider an example:
By applying the formula, we find that the debt-to-net-worth ratio is 0.6. Based on this calculation, the ratio falls below the required threshold of nine to one. Consequently, borrowers in this scenario would not be obliged to inject additional equity. Instead, they can leverage the equity already present on their balance sheet.
The revised SBA rules have greatly improved the accessibility of partner buyout loans, allowing businesses to navigate the process more smoothly. By eliminating the mandatory equity injection for those meeting the debt-to-net-worth ratio criteria, the SBA has created a more favorable environment for obtaining financing and fostering business growth through partner buyouts.
FAQs Related to SBA Partner Buyout Loans
Do the remaining owners have to personally guarantee the SBA loan?
Yes, all remaining owners must personally guarantee the SBA loan as co-borrowers with the business if cases of a complete buyout of a partner(s). If a partial buyout of a partner, i.e., the partner sells less than 100% of her interest, all 20%+ owners post-buyout must guarantee the loan.
What is the loan term for an SBA partner buyout loan?
Partner buyout loans have a maximum term of 10 years, regardless of collateral availability.
What are the advantages of using an SBA loan for a partner buyout compared to other financing options?
Advantages include a 10-year loan term and no collateral requirements, distinguishing SBA loans from traditional commercial loans which typically have five- to seven-year terms.
What are the potential challenges or limitations of obtaining an SBA loan for a partner buyout?
Challenges include personal guarantee requirements for all owners and the thorough application process. Standard SBA eligibility requirements and loan amount limitation of $5,000,000 also exist.
Have SBA partial ownership changes always been allowed?
No, in the past borrowers had to acquire 100% of a business. In essence, an acquisition. Beginning in May 2023, the SBA relaxed the rules allowing existing business owners to completely or partially buyout the equity interests of other partners.
Is 100% financed partner buyout possible?
Yes, so long as the balance sheet of the business has a debt-to-equity ratio below 9:1. However, the SBA lender may require some equity injection, but the SBA does not require it if below the 9:1 ratio.
How do I apply for an SBA loan for a partner buyout, and what documents are typically required?
Our lender match tool, which we call Lender Connect, can connect you with top SBA lenders who specialize in partner buyout loans. The lenders will guide you through the application process and document requirements, but you can find information on SBAlenders.com regarding eligibility and required documents.