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.