By: Patrick Ungashick
A recent technical change in the Small Business Administration’s (SBA) lending policies could make it easier to finance buying out a business partner. Prior to this change, borrowing money to buy out a partner through an SBA loan guarantee program could often be difficult or impossible.
In the past, the fact that the partner buyout process left many businesses with negative equity made it extremely difficult to use SBA 7(a) loans for partner buyouts without needing to contribute a large amount of cash into the company.
Passed last year, the new SBA rules state that the borrower does not need to put down any equity as long as the business has a debt-to-net-worth ratio below 9:1. If the ratio is greater, the borrower will have to contribute 10% equity to qualify for the loan. (For a detailed example, consider this helpful article.)
Keep in mind that the SBA does not actually make loans — it offers to guarantee a portion of loans made by lenders that qualify under its various programs. Under the SBA 7(a) program, the maximum permitted loan is $5 million, of which the SBA may guarantee up to 75%.
Restrictions and Rules
Like most governmental programs, SBA loan programs come with many restrictions and rules. When buying out a partner, some of the most important things to know include:
- Partial buyouts cannot be financed by SBA loans — the buyer is required to purchase 100% of the business. This requirement also applies if existing partner(s) are buying out other partner(s) of the business.
- The seller may not remain involved with the company as an owner, officer, director, or employee.
- If a transitional period is needed after the sale, the seller may serve as a paid consultant for up to 12 months, but not for longer.
There are many other rules to consider — talk with your banking and financial advisors.
What If the SBA Is Not for You?
There are many situations where the SBA is not a solution if seeking to buy out a business partner. The following conditions likely preclude you from using an SBA program:
- The selling owner(s) want(s) to keep some equity in the company, or stay involved in the company post-sale, such as serving on the board.
- You need to borrow more than the SBA 7(a) program maximum of $5 million.
- You are concerned about overloading the company with debt.
- You are concerned about personally guaranteeing the debt, which is usually required.
Many business owners are unaware of other methods to finance buying out a business partner, including bringing in non-controlling equity investors. It is important to carefully explore and weigh all of the options, and therefore work with advisors experienced in situations like yours.