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Getting an SBA 7(a) Loan to Buy Out a Partner
If you run a business with one or more partners, there may come a day when you want to buy one or more of them out. The SBA 7(a) loan can finance this — find out more.
- Before a Buyout, All Partners Must Agree on the Business’s Value
- Different Forms of Buyouts
- Lump-Sum Buyouts
- Earn-Outs
- Buyouts Over Time
- Equity Buyouts
- The Challenges of Getting SBA Financing for Partner Buyouts
- New SBA Rules Make Partner Buyouts Easier
- Case Study: Exiting an Escape Room Business
- Get the Best Loan to Buy Out a Partner
- Related Questions
- Get Financing
If you run a business with a partner or partners, there may come a day when you want to buy one or more of them out. You might simply have different goals, or the partner may want to retire, move to a new location, or shift their career into a new industry altogether.
Whatever the reason, buying out a partner can be expensive proposition— and if you don’t have the funds to do it, you might want to look into an SBA 7(a) loan.
Before a Buyout, All Partners Must Agree on the Business’s Value
Before securing financing for a partner buyout, the partners in a business need to agree on how much the business is actually worth — and how much the partner(s) being bought out will get. In an ideal world, this would all be written down in the business’s partnership agreement; however, in reality, many partnership agreements do not include this information. Even in the case that the agreement does stipulate buyout terms, a variety of things can change throughout the years, potentially invalidating the agreement.
One popular method to value a company involves each of the partners sharing what they believe the company is worth, and, if their numbers diverge significantly, calling in a third-party expert to conduct an independent valuation.
Different Forms of Buyouts
In general, there are four major types of buyouts, though these can often be combined to meet a business’s specific needs. The most common types of buyouts are listed below.
Lump-Sum Buyouts
This is usually the fastest type of buyout, as it provides the exiting partner a one-time cash payment for their equity in the firm. However, it can often be difficult for small business owners to come up with enough cash for a lump-sum buyout, which is where SBA 7(a) loans can come in handy.
Earn-Outs
In an earn-out, the exiting partner will receive payments over time, but they must also stay with the firm during a transition period. In many cases, earn-out payments are tied to company performance, so the better the business does, the more cash the partner can leave with.
Buyouts Over Time
Buyouts over time are similar to earn-outs, in the sense that the exiting partner will be paid over time, but in most cases, they can leave immediately, and will not have to stay on with the company to ‘earn’ their payout.
Equity Buyouts
In this scenario, a new partner will come in, purchasing the exiting partner’s stake in the company. In most cases, the other partner(s) will want the new partner to have some kind of expertise or experience in the industry that can help bring value to the business.
In some situations, a partial equity buyout could be combined with a lump-sum buyout or earn-out, especially if the new partner has experience, but doesn’t have the funds to purchase the exiting partner’s entire stake in the firm. However, partial buyouts are not allowed under SBA rules, so a borrower would have to look for non-SBA financing if they wanted to complete a partial buyout transaction.
The Challenges of Getting SBA Financing for Partner Buyouts
While it’s certainly possible to get SBA financing for a partner buyout, doing so can sometimes be difficult. In many cases, lenders will be worried that the absence of a partner will negatively affect the business — so borrowers will have to prove that they’re more than capable of running the business themselves or that they’re going to bring someone new on that can help.
That means that a business should make sure that their financials are in tip-top shape, and that they have a smart succession/post-exit plan before applying for an SBA loan for a partner buyout.
New SBA Rules Make Partner Buyouts Easier
Despite the challenges of SBA buyout financing, the SBA’s 2018 update on acquisition rules made it much easier for business owners to buy out their partners.
Prior to 2018, the fact that the partner buyout process left many businesses with negative equity made it extremely difficult to use SBA loans for partner buyouts without contributing a large amount of cash.
The newer rules state that, for partner buyouts, the borrower does not need to put down any equity provided that the business has a debt-to-net-worth ratio of 9:1 or less. If the ratio is larger than this, the borrower will need to put 10% down to qualify for the loan.
Case Study: Exiting an Escape Room Business
Ginny and Lesley had been running a successful escape room business together in Sioux Falls, South Dakota. After several years of partnership, Lesley decided to pursue a different path — and decided to sell her share of the business. Ginny, still passionate about the industry, saw this as an opportunity to take full control of the business.
Before moving forward, Ginny and Lesley had to agree on the value of the business. Since their partnership agreement did not specify buyout terms, they decided to each come up with their own valuation. Ginny believed the business was worth $800,000, while Lesley estimated it at $1 million. To resolve the discrepancy, they agreed to hire a third-party expert to conduct an independent valuation. The expert valued the business at $920,000, and both partners accepted this amount as fair.
To finance the buyout of Lesley's share, which amounted to $460,000, Ginny decided to apply for an SBA 7(a) loan. Knowing that lenders might have concerns about her ability to run the business independently, she prepared a detailed plan outlining her vision for the business's future growth and her strategy for maintaining its success.
Ginny applied for a loan of $480,000, which would cover the cost of Lesley's share and provide some additional working capital for the business's ongoing operations. Leveraging the updated SBA rules for partner buyouts, Ginny was able to secure the loan without having to put down any equity, as their debt-to-net-worth ratio was below 9:1.
This is a fictional case study provided for illustrative purposes.
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Related Questions
What are the requirements for an SBA 7(a) loan to buy out a partner?
The requirements for an SBA 7(a) loan to buy out a partner are that the business must have a debt-to-net-worth ratio of 9:1 or less. If the ratio is larger than this, the borrower will need to put 10% down to qualify for the loan. Additionally, the business should make sure that their financials are in tip-top shape, and that they have a smart succession/post-exit plan before applying for an SBA loan for a partner buyout.
For more information, please see the following sources:
What are the advantages of using an SBA 7(a) loan to buy out a partner?
Using an SBA 7(a) loan to buy out a partner has several advantages. First, the SBA's new rules on acquisitions make it much easier for business owners to buy out their partners. In the past, the fact that the partner buyout process left many business’s with negative equity made it extremely difficult to use SBA loans for partner buyouts without contributing a large amount of cash. The new rules state that, for partner buyouts, the borrower does not need to put down any equity, as long as the business has a debt-to-net-worth ratio of 9:1 or less. If the ratio is larger than this, the borrower will to put 10% down to qualify for the loan.
Additionally, SBA 7(a) loans offer competitive interest rates and long repayment terms, making them an attractive option for partner buyouts. The maximum loan amount for an SBA 7(a) loan is $5 million, and the maximum repayment term is 25 years. This makes it easier for borrowers to manage their debt and make their payments on time.
What are the disadvantages of using an SBA 7(a) loan to buy out a partner?
The main disadvantage of using an SBA 7(a) loan to buy out a partner is that lenders may be worried that the absence of a partner will negatively affect the business. This means that borrowers will have to prove that they’re more than capable of running the business themselves— or that they’re going to bring someone new on that can help. Additionally, the business should make sure that their financials are in tip-top shape, and that they have a smart succession/post-exit plan before applying for an SBA loan for a partner buyout. Source
What documents are required to apply for an SBA 7(a) loan to buy out a partner?
In order to apply for an SBA 7(a) loan to buy out a partner, you will need to provide the following documents:
- Business and personal tax returns
- Business financial statements
- Business and personal credit reports
- Business and personal bank statements
- Business and personal financial statements
- Business and personal balance sheets
- Business and personal income statements
- Business and personal cash flow statements
- Business and personal debt schedules
- Business and personal asset schedules
- Business and personal legal documents
- Business and personal insurance documents
- Business and personal lease agreements
- Business and personal loan documents
- Business and personal contracts
- Business and personal licenses
- Business and personal permits
- Business and personal agreements
- Business and personal resumes
- Business and personal references
- Business and personal letters of recommendation
- Business and personal business plans
- Business and personal exit strategies
- Business and personal succession plans
For more information, please contact SBA7(a).Loans today to arrange your risk-free, personal consultation.
What are the eligibility criteria for an SBA 7(a) loan to buy out a partner?
The eligibility criteria for an SBA 7(a) loan to buy out a partner include having a debt-to-net-worth ratio of 9:1 or less. If the ratio is larger than this, the borrower will need to put 10% down to qualify for the loan. Additionally, the business should have their financials in tip-top shape and have a smart succession/post-exit plan before applying for the loan.
Sources: