How the SBA's May 2023 Update Impacts SBA 7(a) Equity Requirements
The update significantly changes equity requirements for SBA loans as well as how sellers’ notes are handled.
The Small Business Administration has updated its guidelines for equity requirements for SBA 7(a) loans. Read on to understand these changes and how you can benefit with your next loan.
These changes took effect on May 11, 2023.
Note that equity injections mean cash (or even other assets) that weren’t a part of the business prior to the loan.
Equity Requirement Changes
The new SBA guidelines introduce changes in equity requirements for different types of ownership changes. These changes are expected to provide more flexibility and opportunities for businesses seeking financing.
A Complete Change of Ownership
Typically, when you buy a business using an SBA 7(a) loan, you would be required to put in at least 10% of the purchase price. That would be considered the equity requirement.
The new change makes a difference when the seller provides the buyer with some kind of financing. This can, in many cases, be considered part of the 10% equity requirement — that said, there are strict eligibility rules.
To begin with, seller financing can be considered for the equity requirement in some cases. If the loan is on full standby for the first 24 months of the loan, it broadly qualifies. If it’s on partial standby — meaning with interest-only payments — then, provided that historical business cash flows cover the payments, it can meet up to three-quarters of the equity requirement. The other portion may not come from the seller.
If you’re planning to use an SBA loan to buy a competitor, this would historically mean taking a loan to buy a business, not expand your existing company.
However, the new change has an impact here: If your company is looking to acquire a competitor in the same industry and area, it will generally classify as an expansion. That means there is no minimum amount of equity that the existing business needs to put in.
Employee Stock Ownership Plans
If a business has an employee stock ownership program (or ESOP), and the business is acquiring a controlling interest of at least 51%, the equity requirements are also waived.
Complete Partner Buyout
If an SBA 7(a) loan is being used to finance upwards of 90% of a partner buyout, the owner or owners who remain must demonstrate that they have been active in business operations and have held the same or an increasing interest in the business for the past 24 months.
At the same time, the company can’t be in too much debt. The most recently completed fiscal year and the present quarter must demonstrate that there’s a debt-to-worth ratio equal to or less than 9:1.
If the owner and debt-to-worth ratio requirements aren’t met, that doesn’t mean you wouldn’t qualify for an SBA 7(a) loan. It just means you would need to provide at least a 10% equity contribution in cash.
Partial Ownership Changes
Similar to a complete partner buyout, for a partial ownership change a business must display it’s not in too much debt. The same 9:1 maximum debt-to-worth ratio requirement is also in effect. If this isn’t met, the borrower must put forth cash of at least 10% of the purchase price.