Complete & Partial Partner Buyouts

When a shareholder acquires all or part of another shareholder’s equity.

Complete Partner Buyout Loan

A complete partner buyout is purchasing 100% of the equity owned by that partner.

For conventional loans down payment is mostly dependent on the Loan to Value (LTV) based on the combined equity ownership.

For an SBA loan the complete partner buyout there is a 10% cash down payment requirement unless two conditions are met.

First, The borrower must have been active in the operations of the business and has been a ten percent or more owner over the last two years. This needs to be attested to by both the borrower and seller.

The second requirement is a Maximum Debt-to-Equity of nine-to-one. This is determined based on the business balance sheet over the most recent year and quarter. Banks have to be able to document both requirements.

It is SBA’s intention that for an SBA loan being used to finance a complete change of ownership, the seller, who no longer has any ownership in the business, is not required to provide a guaranty.

Partial Partner Buyout Loans

The partial partner buyout is when a borrower is purchasing part of the equity owned by a partner. The partner who is selling will remain on as a partner since they are selling just part, and not all, of their equity.

For conventional loans down payment is mostly dependent on the Loan to Value (LTV) based on the combined equity ownership.

For an SBA loan, this loan requires a ten percent cash injection unless two key requirements are met.

First, there is also the same nine-to-one maximum debt-to-worth condition.

The second condition is any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.

Partner Buyout Loans

Comparing SBA & Conventional Equity Injections

An equity injection can be provided by the buyer through a cash down payment or from the seller by providing a seller promissory note (subordinated to lender) or satisfied through a combination of buyer down payment and a seller note. Conventional and SBA loans have completely different rules for equity injections, with conventional being more consistent for all loans but also significantly higher than what SBA loans allow for.

0% or 10% SBA EQUITY INJECTION

The equity injection requirement for partial equity acquisitions is waived if the new owner contributes at least 50% of the equity in the business.

Complete Partner Buyout
For the complete partner buyout there is a 10% cash down payment requirement unless two conditions are met:

1 - The borrower must have been active in the operations of the business and has been a ten percent or more owner over the last two years. This needs to be attested to by both the borrower and seller.

2 - The second requirement is a Maximum Debt-to-Equity of nine-to-one. This is determined based on the business balance sheet over the most recent year and quarter.

Partial Partner Buyout
This loan also requires a ten percent cash injection unless two key requirements are met.

1 - There is also the same nine-to-one maximum debt-to-worth condition.

2 - The second condition is any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.

9:1 DEBT-TO-EQUITY

Calculating the 9:1 ratio

The 9:1 ratio for equity injection in SBA SOP partner buyout loans is a measure of a business's financial health. This ratio compares the business's debt to its equity, which represents the amount of capital invested in the business by its owners. A lower debt-to-equity ratio indicates that the business has more equity and is less reliant on debt, while a higher debt-to-equity ratio suggests that the business is more heavily indebted.

Calculating the 9:1 Ratio: To calculate the debt-to-equity ratio, divide the business's total debt by its total equity. For example, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.

Interpretation of the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to be indicative of financial risk. When a business's debt-to-equity ratio exceeds this threshold, it may be required to inject additional equity into the business to demonstrate its financial stability and reduce the risk of default on an SBA loan.

25% CONVENTIONAL EQUITY INJECTION

25% is the typical equity injection for conventional loans.

While a borrower's personal financial situation, experience and competency, and credit scenario impacts if a bank may require an equity injection, all loans will have a primary equity injection policy and for conventional lenders it is based on Loan to value - LTV. Conventional lenders have maximum LTV requirements typically at 75% but one or two will go to 85%.

For acquisitions, LTV is calculated by combining the value of the buyer's and seller's practices, resulting in most conventional acquisition deals meeting the LTV requirement. If a $1M value practice acquires a $1M value practice then $1M loan/$2M value = 50% LTV. When a $333,000 value practice acquires $1M value practice then $1M/$1,333,000 = 75% LTV. Rule of thumb if both practices valued at same multiple, the buyer’s value needs to be at least 33% of the seller’s value to meet a 75% LTV.

Partner Buyout Loans

Advisors who are in legal partnerships with each owning equity in the same entity and one purchases part or all of the equity of the other.

  • Partnership Buyout Loans

    Advisors who are in legal partnerships with each owning equity in the same entity.

    Both SBA and conventional loans can be used for partner buyouts. However, the SBA treats the equity injection (down payment/seller financing) requirement differently for a partner equity buyout than they do for a non-partner 100% equity acquisition loan. SBA and conventional loans have different criteria in qualifying for a 100% bank-financed partner buyout loan as well.

    Partnership buy-ins are the same as a partial equity acquisition from an SBA financing perspective. SBA lending only recently (10/2023) began allowing partial equity acquisition loans. Now that they are an eligible loan purpose, the ways SBA lending can be utilized for succession financing now encompass both complete and partial, asset and equity, acquisition loans.

    Partnership Scenarios

    Existing Partner(s)

    A partner (or multiple partners) that already has equity and is buying more equity either 100% of the equity of another partner or a portion of the equity the shareholder owns. For example one partner owns 25% and purchasing an additional 25% from the other partner who owns 75%.

    Internal Successor

    When the buyer is already at the firm and the principal sells them part of their equity. For example, the principal has one or more service or associate advisors that are the “chosen ones” to take over the business someday. The principal sells a small percentage of equity to give them some ownership and a long-term commitment to the business. The principal may sell the remaining equity over time in tranches or all at once at retirement.

    Merger Equalization

    When an advisor is merging into another advisor’s business and the new advisor’s business value isn’t equal to the existing advisor’s business valuation so additional funds need to be paid to equate to the percentage of equity the new advisor is going to have. For example an advisor whose business values at $1 million is merging with an advisor whose business values at $2 million and the goal is for both to be 50/50 partners after the sale. The joining advisor would bring merge their assets plus $1 million in cash to buy-in to 50% ownership.

  • Partnership Scenarios

    Existing Partner(s)

    A partner (or multiple partners) that already has equity and is buying more equity either 100% of the equity of another partner or a portion of the equity the shareholder owns. For example one partner owns 25% and purchasing an additional 25% from the other partner who owns 75%.

    Internal Successor

    When the buyer is already at the firm and the principal sells them part of their equity. For example, the principal has one or more service or associate advisors that are the “chosen ones” to take over the business someday. The principal sells a small percentage of equity to give them some ownership and a long-term commitment to the business. The principal may sell the remaining equity over time in tranches or all at once at retirement.

    Merger Equalization

    When an advisor is merging into another advisor’s business and the new advisor’s business value isn’t equal to the existing advisor’s business valuation so additional funds need to be paid to equate to the percentage of equity the new advisor is going to have. For example an advisor whose business values at $1 million is merging with an advisor whose business values at $2 million and the goal is for both to be 50/50 partners after the sale. The joining advisor would bring merge their assets plus $1 million in cash to buy-in to 50% ownership.

  • Lending Considerations

    Conventional lending doesn’t have the same restrictions around down payment as SBA lending, but they do have their own set of qualifiers that, depending on the loan, can be more or less attractive than an SBA loan.

    Cash flow. Conventional loans have a higher DSC (Debt Service Coverage) requirement than SBA loans. The same cash flow requirements apply as an asset acquisition. For instance, if a conventional lender has a 1.50 DSC minimum, then 16.7% more cash flow is needed than for an SBA loan. If the minimum DSC is 1.75, then 52.2% more cash flow is required. Some deals cash flow high enough where this isn’t a concern; however, in some cases, businesses that are heavy on expenses might struggle. If the selling partner’s salary needs to be replaced by another comparable salary, thus disqualifying it as an add-back to cash flow, the loan may qualify for one conventional lender but not another, or only qualify for an SBA loan.

    LTV. Conventional lenders typically range from 75% to 85% LTV (Loan-to-Value) maximum. This means that for conventional loans in a partnership buyout, there will always be a down payment or seller financing requirement if the buying partner has less than 25% or 15% equity, depending on whether the LTV maximum is 75% or 85%. For example, if the buyer has 10% equity in buying out the senior partner who has 90% equity, and the business value is $1 million, then the LTV is 90%. This scenario would necessitate a 15% down payment or seller note (or combination) if the lender has a 75% LTV, and a 5% down payment/seller note if the LTV minimum is 85%.

    Guaranty. In scenarios where multiple partners are buying out one partner’s equity, or when one partner is buying out another, a corporate guaranty or grantor agreements from 20% or more partners may be required. The grantor agreement, or its equivalent, involves non-borrower equity owners personally granting the business collateral for the lender's lien.

    UCC Lien. Another important consideration is the bank's placement of a lien on the entire business. For instance, if there are three or more partners, but only one is obtaining a loan to buy out another partner, the lien will be placed on the entire business, which includes the equity of the non-borrowing equity owner.

  • Complete Partner Buyout Loan:

    A complete partner buyout is purchasing 100% of the equity owned by that partner. For conventional loans down payment is mostly dependent on the Loan to Value (LTV) based on the combined equity ownership. For an SBA loan the complete partner buyout there is a 10% cash down payment requirement unless two conditions are met. First, The borrower must have been active in the operations of the business and has been a ten percent or more owner over the last two years. This needs to be attested to by both the borrower and seller. The second requirement is a Maximum Debt-to-Worth of nine-to-one. This is determined based on the business balance sheet over the most recent year and quarter. Banks have to be able to document both requirements.

  • Partial Partner Buyout Loans:

    The partial partner buyout is when a borrower is purchasing part of the equity owned by a partner. The partner who is selling will remain on as a partner since they are selling just part, and not all, of their equity.

    For conventional loans down payment is mostly dependent on the Loan to Value (LTV) based on the combined equity ownership.

    For an SBA loan, this loan requires a ten percent cash injection unless two key requirements are met.

    First, there is also the same nine-to-one maximum debt-to-worth condition.

    The second condition is any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.

    Conventional lenders usually require this as well. It is SBA’s intention that for an SBA loan being used to finance a complete change of ownership, the seller, who no longer has any ownership in the business, is not required to provide a guaranty.

    Additionally, for 7(a) loans for partial changes of ownership, SBA will measure percentage of ownership post-sale for the purpose of determining who is required to provide a guaranty.

  • How do I understand and calculate the 9:1 ratio?

    The 9:1 ratio for equity injection in SBA SOP partner buyout loans is a measure of a business's financial health. This ratio compares the business's debt to its equity, which represents the amount of capital invested in the business by its owners. A lower debt-to-equity ratio indicates that the business has more equity and is less reliant on debt, while a higher debt-to-equity ratio suggests that the business is more heavily indebted.

    Calculating the 9:1 Ratio: To calculate the debt-to-equity ratio, divide the business's total debt by its total equity. For example, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.

    Interpretation of the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to be indicative of financial risk. When a business's debt-to-equity ratio exceeds this threshold, it may be required to inject additional equity into the business to demonstrate its financial stability and reduce the risk of default on an SBA loan.

    Example of a Business Below the 9:1 Ratio: Suppose a business has $750,000 in debt and $150,000 in equity. Its debt-to-equity ratio would be 5:1, which falls below the 9:1 threshold. In this scenario, the business would not be required to make an equity injection as it is considered financially stable.

    Example of a Business Above the 9:1 Ratio: If a business has $1,200,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 12:1, exceeding the 9:1 threshold. In this case, the business would likely be required to inject additional equity into the business to lower its debt-to-equity ratio and meet the SBA's requirements.

About Equity Injections

Equity injections are basically skin in the game from the lender's perspective for an acquisition loan.

The equity injection has nothing to do with an asset or equity structured purchase, it is referencing the equity of either cash, assets, or a seller note injected into the deal.

An equity injection can be provided by the buyer through a cash down payment or waived based on their current book of business value.

A seller can inject equity into the deal by providing a seller promissory note for a portion of the purchase price.

And equity injections can be satisfied through a combination of buyer down payment and a seller note.

  • What is an equity injection?

    This is basically skin in the game from the lender's perspective for an acquisition loan. The equity injection has nothing to do with an asset or equity purchase, it is referencing equity to mean that either cash or assets are injected into the deal. An equity injection can be provided by the buyer through a cash down payment or waived based on their current book of business value. A seller can inject equity into the deal by providing a seller promissory note for a portion of the purchase price. And equity injections can be satisfied through a combination of buyer down payment and a seller note.

  • It's all about the LTV - Loan to Value

    While a borrower's personal financial situation and credit scenario impacts this the primary equity injection requirements from conventional lenders comes down to the LTV. Conventional lenders have maximum LTV requirements typically at 75% but some can go to 85%.

    Given that LTV is calculated by combining the value of the buyer's and seller's practices, acquisition deals generally bypass LTV qualification hurdles. However, LTV ratios become a crucial challenge in conventional loans when the buying advisor’s practice is valued at or below 33% of the selling practice’s value. In such scenarios, the loan agreement could breach the LTV maximums set by conventional lenders, pushing the need towards an SBA-backed loan.

    For SBA loans, the threshold of concern is when the buyer’s practice is worth approximately 11% of the seller's; this figure is a trigger point for exceeding conventional LTV limits, necessitating the pursuit of an SBA lender for financing.

  • Understanding the New SBA Equity Injection Rules

    The SBA equity injection rule stipulates a ten percent equity injection on loans that lead to a change of ownership. This rule applies to the total project costs and not the loan amount. The 10% equity must come from a source outside the business's existing balance sheet.

    Change of Ownership Loans

    These loans entail acquiring a business, assets, or equity, where the ownership is entirely transferred from the seller to the buyer. These loans include new business purchase loans, expansion business purchase loans, and complete and partial partner buyouts.

    In terms of Equity Injection for a Business Purchase, there are three ways to meet the equity injection requirement: 10% Cash, Full Standby Note, and Partial Standby Note. If choosing a Standby Note, the borrower will have two loans: an SBA loan with the lender, and a promissory note with the seller.

    For changes of ownership resulting in a new owner (complete change of ownership): At a minimum, SBA requires an equity injection of at least 10 percent of the total project costs, (all costs required to complete the change of ownership, regardless of the source of funds) for such transactions.

    Seller debt may not be considered as part of the equity injection unless the seller’s loan does not include a balloon payment and, for the first 24 months of the 7(a) loan, the seller debt is on either (a) full standby; or (b) partial standby (interest payments only being made) and the Applicant’s historical business cash flow supports the ability to make the payments, and at least a quarter of the SBA-required equity injection is from a source other than the seller.

    What are change of ownership loans?

    A loan resulting in a change of ownership is when you are purchasing a business, assets or equity, whereby 100% of the ownership transfers from the seller to the buyer.

    These include:

    A new business purchase loan

    An expansion business purchase loan

    And complete and partial partner buyouts.

  • Equity Buy-in Equity Injection

    The partial partner buyout is when a borrower is purchasing part of the equity owned by a partner. The partner who is selling will remain on as a partner since they are selling just part, and not all, of their equity.

    This loan also requires a ten percent cash injection unless two key requirements are met.

    A Maximum Debt-to-Worth of nine-to-one (9:1). This is determined based on the business balance sheet over the most recent year and quarter.

    Any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.

    Calculate the 9:1 ratio

    The 9:1 ratio for equity injection in SBA SOP for partner buyout loans is a measure of a business's financial health. This ratio compares the business's debt to its equity, which represents the amount of capital invested in the business by its owners. A lower debt-to-equity ratio indicates that the business has more equity and is less reliant on debt, while a higher debt-to-equity ratio suggests that the business is more heavily indebted.

    Calculating the 9:1 Ratio: To calculate the debt-to-equity ratio, divide the business's total debt by its total equity. For example, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.

    Interpretation of the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to be indicative of financial risk. When a business's debt-to-equity ratio exceeds this threshold, it may be required to inject additional equity into the business to demonstrate its financial stability and reduce the risk of default on an SBA loan.

    Example of a Business Below the 9:1 Ratio: Suppose a business has $750,000 in debt and $150,000 in equity. Its debt-to-equity ratio would be 5:1, which falls below the 9:1 threshold. In this scenario, the business would not be required to make an equity injection as it is considered financially stable.

    Example of a Business Above the 9:1 Ratio: If a business has $1,200,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 12:1, exceeding the 9:1 threshold. In this case, the business would likely be required to inject additional equity into the business to lower its debt-to-equity ratio and meet the SBA's requirements.

  • Equity Injection If Cash Payment

    The equity injection can be paid by the borrower in cash, preferably wired to the lender a week or two before the loan closing. The money can come from savings, investments, a Home Equity Line of Credit (HELOC), or as a gift (with a gift letter as proof). Lenders usually require the most recent account statement for verification.

    Full Standby Note

    The SBA made a big change to the full standby seller note. Now the seller can finance the full ten percent of the equity injection requirement.

    No principal or interest can be paid during the first two years standby period.

    This option enables the borrower to purchase a business with no money down.

    Partial Standby Note

    A partial standby is where interest only payments can be made for the first two years but not principal payments.

    The seller can finance up to 7.5% in a partial standby note.

    The SBA requires 2.5% to come from a source other than the seller.

    Adequate cash flow has to support the partial standby option.

  • Advisor Expansion Through Acquisition

    Expansion Loans

    Business Expansion Loans do not require an equity injection. When an existing business starts or acquires a business that is in the same 6-digit NAICS code with identical ownership and in the same geographic area as the acquiring entity and they are co-borrowers, SBA considers this to be a business expansion and not a new business.

    Expansion Acquisition

    When an existing business purchases another established business.

    There is no down payment requirement for one business purchasing another business if three conditions are met.

    1. The target business to purchase is in the same industry

    2. The target business to purchase is in the same geographical area as your current business

    3. The exact same current ownership structure will be applied to the purchased business.

    If all three of these conditions are met then no equity injection is required. If all three conditions are not met, then the ten percent equity injection rules apply.

  • What down payment sources qualify for SBA loans?

    Savings

    Liquidating from investment account(s)

    Gift (gift letter must be provided)

    HELOC

    What is the process of making payment?

    For SBA loans the typical way it works is the down payment is wired to the bank. The bank is required by the SBA to see statements that show the amount was in that account for two full months before the down payment was sent. If the money was pulled from multiple accounts then multiple account statements will have to be provided.