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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.
FAQ for Partial Equity Buy-ins
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The U.S. Small Business Administration (SBA) was created in 1953 to assist small businesses with guaranteed loans covering many of the small business needs for most industry types. The 7(a) program is the Small Business Administration’s flagship program and all SBA data on this website is referring to loans under the SBA 7(a)program.
The mission of the Small Business Administration is "to maintain and strengthen the nation's economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters".
Through the SBA 7(a) guaranteed lending program, the SBA guarantees part of the business loan that a SBA approved lender provides. In the case of a loan default, the lender isn’t on the hook for all of the unpaid loan amount. This SBA guarantee results in lenders providing loans to small businesses that they otherwise would not.
See sba.gov
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Partial Equity Buy-in Considerations
DEAL GUARD RAILS
There are few guard rails in deal structure for qualifying equity buy-in loans as long as they make sense to the (experienced) lender.SELLER CONSULTING
Ongoing seller involvement is a given in equity buy-ins.GUARANTORS
While a case-by-case basis the equity owners with 20% or more will execute grantor agreement with the lender. The borrower is a personal guarantor and 20% partners have a grantor agreement.COLLATERAL
No personal property collateral but there is a UCC lien on all current and future business assets of the entire entity.
DSC CASH FLOW
When a W2 advisor or internal manager (not owning a book or practice) are buying into a practice with an equity buy-in the cash flow is based on the net distributions received against the annual debt service.BANK ACCOUNT REQUIREMENT
While moving your bank operating account to the bank providing a business loan under $5 million isn’t typical in the advisory lending niche, it is even less common in a buy-in loan where the borrower may be only purchasing 5% or 10% of the equity. -
SBA Now Allows for Equity Buy-ins
New or existing shareholder purchasing a portion of equity from a partner.
Partial Equity Acquisitions
The SBA now recognizes and allows partial equity acquisitions. This flexibility means that interested buyers can acquire a share of an existing business without needing to purchase the entire organization.
Eligibility Requirements
For a buyer to qualify for an SBA loan financing a partial equity acquisition, they must acquire at least 20% ownership interest in the business. Simultaneously, the existing owner(s) need to retain a minimum of 20% ownership interest in the business.
Equity Injection Requirements
The equity injection requirement for partial equity acquisitions is waived if the new owner contributes at least 50% of the equity in the business.
Guaranty Requirements
All owners holding 20% or more of the business must provide a full, unlimited guarantee for any SBA loan financing the business's purchase. This requirement applies regardless of whether it is a complete or partial partner buyout.
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Partial Equity Buy-in Considerations:
DEAL GUARD RAILS
Key guard rails are earn-out structures are ineligible. The inability to maintain seller as an employee post-sale isn’t relevant in equity buy-ins.SELLER CONSULTING
Ongoing seller involvement is a given in equity buy-ins.GUARANTORS
The borrower plus any 20%+ remaining partner is a personal guarantor and subject to any applicable personal property collateral requirements.COLLATERAL
A UCC lien on all current and future business assets is placed on the business. Personal property can be required for loans over $500,000 and when having 25% equity in the property.
DSC CASH FLOW
When a W2 advisor or internal manager (not owning a book or practice) are buying into a practice with an equity buy-in the cash flow is based on the net distributions received against the annual debt service.BANK ACCOUNT REQUIREMENT
This isn’t typically required or an issue anyway but especially in equity buy-ins. -
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.
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What Remaining 20% Partners Need to Know About Equity Buy-in Loans
Different conventional lenders approach partial equity purchases or buy-ins differently. For partner buy-ins there is still the cash flow and LTV considerations that a partner buyout have but often the issue for partner buy-in loans is the lender’s guaranty and lien requirements.
A lien is placed on the entire business
The bank will place a lien on the entire business even though it is lending for an equity buy-in of only 1% of the business. So if only one is getting a loan, the lien is going to encompass the equity of the non-borrowing partner has as well.
It's a blanket UCC lien and covers all equity and client assets, now and in the future, and this stays in place the duration of the loan.
Equity Injection is either 0%, 10%, or 25%
The equity injection, which includes the cash down payment and/or seller financing required for the loan, will range from 0% if the SBA's 9:1 ratio is met, to 10% if it is not. In this scenario, seller financing is not allowed, necessitating a 10% cash down payment.
Conventional loans typically require a 25% equity injection, with a maximum loan-to-value (LTV) ratio of 75%.
20% Partners = personal guaranty on SBA Loans
SBA mandates that all partners with at least a 20% stake provide personal guarantees and comply with collateral requirements. A significant concern lies in the collateral requirements related to personal property.
If the buying advisor does not have equity in their home equivalent to the loan amount—an issue that occurs approximately 99.99% of the time—then for loans exceeding $500,000, a 20% partner with 25% equity in their home (outside of Texas) would face a junior lien placed on their property to secure the loan for the other buying advisor.
20% Partners = grantor on conventional Loans
For conventional loans then a corporate guaranty or grantor agreement would be required. The grantor agreement (or equivalent) is where the non-borrower equity owners personally grant the business collateral to the lender.
Some conventional lenders based on the buyer and overall loan scenario may also require one or more personal guaranties from existing partners. Conventional lenders are very case-by-case basis on these types of deals but personal guaranties are not common.
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.
See equity injection section for more details.
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