Getting an SBA 7(a) Loan to Buy Out a Partner
Running a business with partners can be a rewarding endeavor, but circumstances change, and you might find yourself in a position where you want to buy out one or more of your partners. Whether it’s due to differing goals, retirement plans, a desire to move in a new direction, or any other reason, loan to buy buyouts partner can be complex and costly. If you’re short on funds for this endeavor, exploring the option of an SBA 7(a) loan can be a prudent step.
Understanding the SBA 7(a) Loan:
The Small Business Administration (SBA) offers various loan programs to support small business owners, and the 7(a) loan is one of the most versatile and commonly used options. It can be employed for a range of purposes, including working capital, business acquisitions, startup costs, and, notably, partner buyouts.
Quick Overview of The Key Aspects of SBA 7(a) Loans:
Loan Amount: SBA 7(a) loans can range from $50,000 to $5 million, making them suitable for businesses of various sizes.
Interest Rates: The interest rates for these loans typically fall between 9.50% to 11.25%, making them competitive within the lending market.
Loan Term: SBA 7(a) loans offer flexible loan terms, ranging from 10 to 25 years, depending on the specific use of the funds.
Recourse: These loans are fully recourse, meaning the borrower is personally liable for repaying the loan.
Amortization: SBA 7(a) loans can have an amortization period of up to 25 years, providing borrowers with extended repayment options.
Before a Buyout, All Partners Must Agree on the Business’s Value:
Before you embark on securing financing for a partner buyout, it’s crucial that all partners involved agree on the actual value of the business and the terms of the buyout. Ideally, this information would be laid out in the business’s partnership agreement.
However, many such agreements lack detailed buyout provisions, and even if they do exist, changing circumstances over time can render them outdated.
A common approach to determining a business’s value is for each partner to provide their assessment of what the company is worth. If there are significant disparities in these valuations, seeking the expertise of a third-party business valuator can help establish an independent and fair valuation.
Different Forms of Buyouts:
Partner buyouts come in various forms, and the choice depends on the preferences and circumstances of all parties involved. Here are the primary types of buyouts:
Lump-Sum Buyouts:
In this arrangement, the exiting partner receives a one-time cash payment for their equity in the business. However, coming up with a substantial lump-sum payment can be challenging for small business owners, making SBA 7(a) loans a viable solution.
Earn-Outs:
Earn-outs involve payments spread over time, often tied to company performance during a transition period. The exiting partner receives compensation based on business success, aligning their interests with the ongoing performance of the company.
Buyouts Over Time:
Similar to earn-outs, these buyouts involve payments over time, but the exiting partner can usually depart immediately without continued involvement in the business.
Equity Buyouts:
In equity buyouts, a new partner acquires the departing partner’s stake in the business. Typically, the remaining partner(s) seek a new partner with industry expertise or experience to bring added value.
It’s important to note that while partial equity buyouts can be considered, the SBA’s rules do not permit partial buyouts, necessitating alternative financing options for such transactions.
The Challenges of SBA Financing for Partner Buyouts:
While SBA financing can be a viable solution for partner buyouts, it’s not without its challenges. Lenders may express concerns about the potential impact of a partner’s departure on the business’s stability and success.
To overcome these concerns, borrowers must demonstrate their capability to manage the business independently or present plans for bringing in a new partner who can contribute positively.
Ensuring that your business’s financials are in excellent shape and devising a well-thought-out succession or post-exit plan is essential before applying for an SBA loan for a partner buyout.
New SBA Rules Make Partner Buyouts Easier:
In 2018, the Small Business Administration introduced new rules that simplified the process of using SBA loans for partner buyouts. Before these changes, partner buyouts often resulted in businesses facing negative equity, making it challenging to secure SBA financing without a substantial cash contribution.
Under the updated rules, businesses seeking partner buyout financing do not need to provide any equity if their debt-to-net-worth ratio is 9:1 or less. For those with a larger ratio, a 10% down payment may be required to qualify for the loan.
Conclusion:
When it comes to buying out a partner in your business, the SBA 7(a) loan to buy presents a viable financing option. It offers flexibility in loan amount, competitive interest rates, extended repayment terms, and, with the updated rules, reduced equity requirements for partner buyouts. However, it’s essential to address the challenges associated with partner departures, such as demonstrating your capability to sustain and grow the business independently or with a new partner.
