Getting an SBA 7(a) Loan to Buy Out a Partner
If you run a business with a partner or partners, there may come a day when you want to buy one or more of them out. You might simply have different goals, or the partner may want to retire, move to a new location, or shift their career into a new industry altogether. But, whatever the reason, buying out a partner can be expensive proposition— and if you don’t have the funds to do it, you might want to look into an SBA 7(a) loan.
Before a Buyout, All Partners Must Agree on the Business’s Value
Before securing financing for a partner buyout, the partners in a business need to agree on how much the business is actually worth— and how much the partner(s) being bought out will get. In an ideal world, this would all be written down in the business’s partnership agreement; however, in reality, many partnership agreements do not include this information. Even in the case that the agreement does stipulate buyout terms, a variety of things can change throughout the years, potentially invalidating the agreement.
One popular method to value a company involves each of the partners sharing what they believe the company is worth, and, if their numbers diverge significantly, calling in a third-party expert to conduct an independent valuation.
Different Forms of Buyouts
In general, there are four major types of buyouts, though these can often be combined to meet a business’s specific needs. The most common types of buyouts include:
Lump-sum buyouts: This is usually the fastest type of buyout, as it provides the exiting partner a one-time cash payment for their equity in the firm. However, it can often be difficult for small business owners to come up with enough cash for a lump-sum buyout, which is where SBA 7(a) loans can come in handy.
Earn-outs: In an earn-out, the exiting partner will receive payments over time, but they must also stay with the firm during a transition period. In many cases, earn-out payments are tied to company performance, so the better the business does, the more cash the partner can leave with.
Buyouts over time: Buyouts over time are similar to earn-outs, in the sense that the exiting partner will be paid over time, but in most cases, they can leave immediately, and will not have to stay on with the company to ‘earn’ their payout.
Equity buyouts: In this scenario, a new partner will come in, purchasing the exiting partner’s stake in the company. In most cases, the other partner(s) will want the new partner to have some kind of expertise or experience in the industry that can help bring value to the business. In some situations, a partial equity buyout could be combined with a lump-sum buyout or earn-out, especially if the new partner has experience, but doesn’t have the funds to purchase the exiting partner’s entire stake in the firm. However, partial buyouts are not allowed under SBA rules, so a borrower would have to look for non-SBA financing if they wanted to complete a partial buyout transaction.
The Challenges of Getting SBA Financing for Partner Buyouts
While it’s certainly possible to get SBA financing for a partner buyout, doing so can sometimes be difficult. In many cases, lenders will be worried that the absence of a partner will negatively affect the business— so borrowers will have to prove that they’re more than capable of running the business themselves— or that they’re going to bring someone new on that can help. That means that a business should make sure that their financials are in tip-top shape, and that they have a smart succession/post-exit plan before applying for an SBA loan for a partner buyout.
New SBA Rules Make Partner Buyouts Easier
Despite the challenges of SBA buyout financing, the SBA’s new rules on acquisitions make it much easier for business owners to buy out their partners. In the past, the fact that the partner buyout process left many business’s with negative equity made it extremely difficult to use SBA loans for partner buyouts without contributing a large amount of cash. The new rules state that, for partner buyouts, the borrower does not need to put down any equity, as long as the business has a debt-to-net-worth ratio of 9:1 or less. If the ratio is larger than this, the borrower will to put 10% down to qualify for the loan.