What 20% Partners Need to Know About Equity Buy-ins
What 20% Partners Need to Know About Equity Buy-ins
Equity buy-ins, when a non-shareholder purchases a partial portion of the equity has been on the rise. As succession planning and equity retention strategies expand in popularity, so do partial equity buy-in loans. While there are benefits behind equity offerings there are also financing challenges and concerns to address. Of course some firms will self-finance equity buy-ins internally and others feel internal financing defeats the whole purpose of a buy-in. And still others would like to have buy-ins bank financed but due to bank requirements have chose to self finance these deals instead.
What could the drawbacks be with bank financing equity buy-ins? Often times there are none and sometimes the drawbacks are insurmountable unless minds or circumstances change. Let’s go over the recent expanded lending options available for equity buy-ins and what the 20% plus partners need to know.
Until this last year equity buy-ins were not an eligible loan purpose, but now they are. Before the SBA made this change it was only conventional loans which were available to advisors for equity buy-in lending. Now advisors have two very different loan option programs for equity buy-ins. Since SBA loans have a wider qualifying criteria than conventional loans, more advisors qualify today for equity buy-in loans than they did a year ago.
Different lenders approach partial equity purchases or buy-ins differently. For equity buy-ins there is still the cash flow and LTV considerations that a partner buyout (only one revenue cash flow source and one valuation instead of two) have but often the issue for partner buy-in loans which give remaining 20% partners heartburn is the lender’s guaranty, grantor, and lien requirements.
A lien is placed on the entire business:
The bank will place a lien on the entire business even though it is lending for an equity buy-in of only 1% of the business. So if only one is getting a loan, the lien is going to encompass the equity of the non-borrowing partner has as well. It's a blanket UCC lien and covers all equity and client assets, now and in the future, and this stays in place the duration of the loan.
Equity Injection is either 0%, 10%, or 25%:
The equity injection, which includes the cash down payment and/or seller financing required for the loan, will range from 0% if the SBA's 9:1 ratio is met, to 10% if it is not. In this scenario, seller financing is not allowed, necessitating a 10% cash down payment. Conventional loans typically require a 25% equity injection, with a maximum loan-to-value (LTV) ratio of 75%.
20% Partners = personal guaranty on SBA Loans:
SBA mandates that all partners with at least a 20% stake provide personal guarantees and comply with collateral requirements. A significant concern lies in the collateral requirements related to personal property. If the buying advisor does not have equity in their home equivalent to the loan amount—an issue that occurs approximately 99.99% of the time—then for loans exceeding $500,000, a 20% partner with 25% equity in their home (outside of Texas) would face a junior lien placed on their property to secure the loan for the other buying advisor.
20% Partners = grantor on conventional Loans:
For conventional loans then a corporate guaranty and/or grantor agreement would be required. The grantor agreement (or equivalent) is where the non-borrower equity owners personally grant the business collateral to the lender. Some conventional lenders based on the buyer and overall loan scenario may also require one or more personal guaranties from existing partners. Conventional lenders are very case-by-case basis on these types of deals but personal guaranties are not common.
Depending on an endless combination of variables some 20% partners will be in a position where the bank requirements for equity buy-in loans are mostly inconsequential. For others it could mean adjusting how and when they disburse equity or even implementing alternatives like initially awarding phantom or synthetic equity and converting to real equity later. Planning for equity buy-in financing ideally should be considered early in the process when your equity sharing policies are established (but it never is). If you are considering selling partial equity then consider having a conversation with us about how the financing would look for your structure or to pre-qualify an internal buyer for a buy-in loan.