Business succession planning is vital to the longevity of any business. This is especially true when a business is owned by two or more individuals, for seldom do business partners share the same retirement and life goals.
Therefore, a business is most likely to experience an interruption or even worse, the ceasing of operations altogether, when one partner is ready to exit the business and the others are not. This matter is further complicated when the partnership also owns both the business and the real estate from which the business operates.
Possible scenarios, when one partner is ready to exit and the others are not, include a private loan from the partner exiting the business to the remaining partners, an earn-out for the benefit of the partner exiting the business paid out over several years or a venture capital non-bank funding source. These funding sources are often expensive and complicated.
None of these scenarios likely meet the goals of all parties involved.
On the other hand, if a partner buy-out is structured correctly, the SBA 7(a) loan program is perfectly suited to meet the goals of both the partner exiting the business and the remaining partners.
The partner exiting the business is able to receive full payment for their equity ownership and therefore enjoy retirement by dropping all involvement in the business.
The partners remaining in the business take 100% control with no cash out of pocket as long as the business balance sheets for the most recently completed fiscal year and current quarter reflect a debt-to-worth ratio of no greater than 9:1 prior to the change in ownership.
Other benefits of the SBA 7(a) loan program include:
- SBA loan interest rates are competitive with conventional rates
- SBA guarantee fees may be financed instead of paid out of pocket preserving precious operating capital
- The loan is amortized over a 10 year period
- There is no prepayment penalty
- There are no financial covenants or burdensome annual documentation review requirements
- When the real estate is owned by all partners and included in sale, there is the ability for the partners remaining in the business to combine the partner buy-out with the real estate purchase into one loan amortized over a 25 year period
In conclusion, the following three tests must be met to ensure the partner buy-out passes the SBA’s eligibility requirements.
- The partners remaining in the business must own 100% of the business upon change of ownership and certify they have been actively participating in the business and held the same ownership interest for at least the past 24 months
- There is no earn-out to the benefit of the partner exiting the business in the purchase contract
- There is no mezzanine debt in a second position to the SBA Preferred Lending Partner