ADVISOR LOANOLOGY

“An ounce of prevention is worth a pound of cure.”

~ Benjamin Franklin

Selling to Successor:
What to Know

Selling to an internal successor is what most advisors prefer or plan.

It might be to an existing partner, junior or associate advisor, or even a family member. In most cases an internal advisor can qualify for an acquisition loan for the full purchase price.

  • Can I spread out payments over multiple years without seller financing?

    Yes. Part of the purchase can be placed into escrow and then disbursed over multiple years.

  • Can they get a loan for the down payment and then do an earn-out for the rest?

    If they qualify for a conventional loan they can. Any form of an earn-out is not allowed with an SBA loan.

  • Can I help my successor avoid a down payment?

    Other than guarantying the loan, they would need to be 1099 for one year prior to the purchase and own enough assets to value at just over 10% of the purchase price.

  • Can I lend successor money for a down payment?

    You can’t lend it to them.

  • Can they use the phantom stock I gave them as a down payment?

    Conventional: If the buyer is doing a conventional loan, no problem.

    SBA: The equity owned needs to be reported on their last two years tax returns to qualify. If the equity is phantom stock, a verbal agreement, or equity that you gave that has no benefit unless you sell someday, then lenders typically will not view that as eligible equity ownership that could be applied as the down payment.

  • What's this SBA equity injection seller financing all about?

    For advisors with no equity ownership, no 1099 income, and no clients owned, then a 10% down payment would be required. Of this you can choose to seller finance 5% but the note would be on a 10 year standby note.

    This means that while interest can accrue the buyer would not be able to make any P&I payments on that 5% note while the SBA loan is still active. SBA acquisition loans (without property) are 10 years.

    For a lot of internal successors there is a big difference in their ability for coming up with a 5% down payment vs. coming up with 10%. With a little planning you can help your internal successor in this situation either prepare for a down payment or avoid a down payment all together.

  • Should I ever consider guarantying the loan?

    As a general rule, no. However, there are circumstances that could warrant it. If you do guaranty then you will likely only be able to protect yourself in clawing back the equity that was sold.

  • What does it cost to see if my successor qualifies?

    Nothing, AdvisorLoans provides pre-approvals for free.

Next-Gen & W2 Advisor Lending

How does financing work for a W-2 advisor seeking to buy out their book of business and transition fully to a 1099 compensation structure, or possibly a hybrid W-2/1099 role?

What steps must the W-2 advisor take to gain ownership of their book while compensating the practice or senior advisor with an override, platform fee, or overhead fee for the support provided?

There are options.

W2 & Next-gen Advisor Buying Their First Book/Assets

Financing partial and complete books and practices is entirely possible for W2 advisors and depending on your perspective, this model offers its own set of benefits.

Can sell partial books of assets as one time events, then more maybe later as a we'll-see-how-it-goes future sale, or sell assets in structured tranches over time.

Unlike selling partial equity, selling partial assets avoids personal or corporate guaranties on the selling side.

The equity injection requirement for W2 advisor buying a book is 10% which can be cash down payment or seller financed on a two-year standby note. But the equity injection for an expansion loan is waived. So if the W2 advisor first becomes an established advisory business then it could be structured as an expansion because it in fact would be. These are looked at on a case by case basis but bottom line is that the SBA makes it viable to get loans at 90% and 100% LTV compared to a 75% typical LTV conventional loan.

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.

Equity Buy-in 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.

Next-Gen Succession Equity Buy-ins

Tranches Through SBA Lending

5% now, then 76% to 94% in 2 years, then the last shares whenever final retirement happens

This is not an official SBA program but how we work with the SBA rules to achieve desired outcome of a next-gen advisor going from no equity to 100% ownership over time based on financing timeline benchmarks. This structure outline can work for a senior partner or partners who are ready to slow down but not retire, who want to sell most but not all of their equity to firm employees and next-gen advisors, wants to help position these employees for SBA financing, and does not want to guaranty their loans.

1. Minority 5% Equity

Some small amount level of equity like 5% is transferred to next-gen advisor(s). This can be paid in cash or provided as services rendered or converted from phantom stock or the promise of equity into actual equity.

An SBA loan can be done for this initial piece but a seller guaranty from all 20% partners would be required.

2. Wait 2 Years

The next-gen advisor receives K1s for ownership for two years. At anytime after 2 years the next-gen minority partner(s) can purchase can pursue full financing to buy out another 76% to 94% partial equity purchase.

Other partners with less than 20% do not have to personally guaranty the loan.

3. 76% to 94% Equity Sell

Next-gen advisor(s) purchases a sum equity that can range from 76% equity which leaves seller with 19% to 94% equity which leaves seller with 1%. This is now a partial partner buyout loan. No seller guaranty required.

4. Retire When Ready

Senior advisor maintains minority partner status owning from 1% to 19% of equity. Can sell the rest at once or in tranches to the same advisor or to whomever the partnership agreement allows for.

1.15 DSC: The deal structure needs to cash flow at better than 1.15 DSC.e deal

9:1: The business balance sheets for the most recent completed fiscal year and current quarter must reflect a debt-to-worth ratio of no greater than 9:1 prior to the change in ownership.

W2 Advisor Book Buyout SBA Loans

W2 Advisor Buys A Book

Asset Purchase / Book Buyout

No Down Payment Option
This can be paid 10% cash down but is not required if seller instead does the 10% two-year standby note.

10% Seller Standby Financing
The seller can eliminate the need for the buyer to come up with a 10% cash down payment with a two-year full standby seller note. The 2 conditions is the note can't have a balloon payment and must not have any payments (P&I) paid during the first 24 months. These are typically 7-10 year terms with the first 2 years on standby.

No Seller Guaranty
This is a simple asset/book sale and there is never a seller guaranty in an asset sale, especially a partial book buyout.

W2 Advisor Who Also Has 1099 Business Buys a Book

Expansion Acquisition

No Down Payment
There is no down payment required by the SBA and it will only be dependent on the bank feeling comfortable with the experience and credit of the advisor in relation to the size loan they are seeking.

No Seller Financing
Since there is no equity injection requirement then there is not a down payment or seller financing requirement. The only seller financing required is when there are qualifying or cash flow issues.

No Seller Guaranty
This is a simple asset/book sale and there is never a seller guaranty in an asset sale, especially a partial book buyout. SBA seller guaranties come on the partial equity buy-in side but not partial asset side.