Equity Buy-ins Now Eligible for SBA Loans
Equity Buy-ins Now Eligible for SBA Loans
The Small Business Administration (SBA) rolled out updates to their loan policies, making it possible to secure loans for partial ownership changes. This shift addresses a significant need in the advisory lending space that traditional lenders have typically dominated.
For 25 years the SBA has been a lending resource for advisors, but partial equity buy-ins—where someone buys only a portion of a the equity—have been off the table. Until recently. The SBA revised their operating procedures and one of the biggest impacts for advisors is that partial equity buy-ins are now allowed under their partial change of ownership rules.
What’s a Partial Change of Ownership According to the SBA?
A partial change of ownership occurs when a non-partner buys less than 100% of a business's equity. This also includes existing partners buying partial shares, which the SBA recognizes as a partial partner buyout. The new policy allows the selling owner to stay involved in the business operations, which might seem a bit obvious in a partial equity purchase scenario.
Now, let’s talk about the cash injection requirement: a 10% cash contribution is needed unless two key criteria are met:
A maximum debt-to-worth ratio of nine-to-one.
Any remaining owners with 20% or more equity must adhere to SBA guarantor requirements, including personal guarantees and property collateral.
Let’s break down the requirements:
Guaranty Requirements
All owners holding 20% or more post-acquisition must provide a full, unlimited guarantee for any SBA financing related to the equity buy-in. This is essential due to their significant ownership stake and shared responsibility for the business's success.
20% Partner’s Personal Property: While the SBA doesn’t require borrowers to have equity in real estate to qualify, if they do, an SBA lender may need to use it as collateral under certain conditions. For loans exceeding $500K, if a borrower holds 25% equity or more in any personal property, it will be required as collateral, up to the full loan amount. If you're considering an SBA loan over $500K and have 25% equity in your home, establishing a Home Equity Line of Credit (HELOC) can help reduce your equity to below 25%, avoiding a junior lien by the SBA lender.
Change of Ownership Reminder: If you were subject to the SBA guarantee requirements six months prior to your loan application, you still need to comply, even if your ownership stake has dropped below 20%. The only exception is if you’ve completely divested your interest before applying. Complete divestiture means giving up all ownership and severing ties with the applicant and any affiliated Eligible Passive Company, including any form of employment.
Equity Injection Requirements
An equity injection signifies both the borrower's and, in some respects, the seller's "skin in the game" for an acquisition loan. It refers to the infusion of cash or assets into a transaction, aimed at reducing the leverage involved in an asset or equity purchase.
Calculating the 9:1 Ratio: The 9:1 ratio for equity injection in SBA SOP partner buyout loans serves as an important measure of a business’s financial health. This ratio compares the business’s total debt to its equity, reflecting the capital invested by its owners. A lower debt-to-equity ratio indicates greater equity and reduced reliance on debt, while a higher ratio suggests a heavier debt burden.
To calculate the debt-to-equity ratio, simply divide the business's total debt by its total equity. For instance, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.
Interpreting the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to indicate financial risk. When a business's debt-to-equity ratio surpasses this threshold, it may be necessary to infuse additional equity to demonstrate financial stability and mitigate the risk of default on an SBA loan.
For partial equity acquisitions, the equity injection requirement is waived if the new owner contributes at least 50% of the business's equity.
In conclusion, the shift in the SBA's policy is a significant positive development for advisors. While an SBA equity buy-in loan may not be suitable for every advisor or scenario, the same applies to other types of SBA loans. We receive numerous inquiries on this topic, so if you have questions, please don't hesitate to reach out!