LOANOLOGY
EQUITY INJECTION
Equity Injections
Planning to buy a business, expand with a new location, or fund a partner buyout with an SBA loan? The equity injection—your “skin in the game”—is a key requirement showing your commitment to the deal.
What Is an Equity Injection?
An equity injection is the cash or assets you contribute to a business acquisition or expansion to reduce the loan amount and lender risk. It shows you’re invested in the project’s success, whether you’re buying a single-unit business, multiple locations, or a rural operation. The injection can come from your funds, a seller’s promissory note, or other sources, depending on SBA rules.
Purpose: Lowers leverage, ensuring the loan is sustainable, like funding a $1 million acquisition with a $100,000 injection.
SBA Requirement: Typically 10% of total project costs (all costs to complete the deal, not just the loan amount) for change of ownership loans.
Equity Injection With Conventional Loans
While a borrower’s personal financial situation and credit profile have influence, the primary equity injection criteria from conventional lenders focus on the Loan-to-Value (LTV) ratio. Typically, conventional lenders cap LTV at 75%, although some may extend 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. In this case an equity injection (down payment and/or seller financing) is not required based on LTV but the lender may have other reasons they may want to see "some level" of injection (5%-10%).
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 (or visa-versa) to meet a 75% LTV.
Understanding the New SBA Equity Injection Rules
The SBA requires a minimum 10% equity injection for loans facilitating a change of ownership, calculated based on total project costs, not the loan amount. This contribution must originate from sources outside the business’s existing balance sheet, such as personal cash, gifts, or seller financing under strict conditions. LoanBox guides you through these requirements to ensure compliance and a seamless loan process.
Equity Injection for Change of Ownership Loans
Change of ownership loans involve acquiring a business, its assets, or equity, transferring 100% ownership from seller to buyer. Here’s how equity injections apply:
Types of Change of Ownership Loans
New Business Purchase: Buying an existing business, like a retail or service operation, to launch your entrepreneurial journey.
Expansion Acquisition: An existing business purchasing another, such as adding a new location to your service enterprise.
Complete Partner Buyout: Buying out a partner’s full equity share, transferring 100% ownership to you.
Partial Partner Buyout: Purchasing part of a partner’s equity, with the seller retaining some ownership.
Equity Injection Requirements
Standard Rule: For complete change of ownership loans (e.g., new business purchase, expansion acquisition), the SBA requires a minimum 10% equity injection of total project costs, sourced outside the business’s existing balance sheet.
Example: A $1 million project (purchase price + closing costs) requires a $100,000 injection, which cannot come from the business’s cash reserves.
Sources:
Cash: From personal savings, investments, or a Home Equity Line of Credit (HELOC), wired to the lender 1–2 weeks before closing, verified with recent account statements.
Gift Funds: Allowed with a gift letter confirming no repayment obligation.
Seller Note: A promissory note from the seller can cover up to 50% of the injection, subject to SBA rules (see below).
Assets: Non-cash assets (e.g., equipment) may count if independently appraised above net book value.
Seller Note Options
Seller notes allow the seller to finance part of the equity injection, reducing your upfront cash need.
Full Standby Note:
Covers up to 50% of the 10% injection (e.g., $50,000 for a $1 million project, with the remaining $50,000 from other sources like cash).
Terms: No principal or interest payments for the entire term of the 7(a) loan, ensuring your cash flow supports the SBA loan. The note must be subordinated to the SBA loan with no acceleration clauses.
Benefit: Reduces your cash contribution, ideal for buyers with strong cash flow but limited reserves.
Note: Partial standby notes with interest-only payments are not permitted. Seller notes exceeding 50% of the injection are ineligible.
Expansion Acquisition Equity Injections
Business Expansion Loans
Business expansion loans involve an existing business starting or acquiring another in the same 6-digit NAICS code, with identical ownership and in the same geographic area, treated as co-borrowers. These are considered expansions, not new businesses, with different rules.
Expansion Equity Injection Rules
No Equity Injection Required: If the following conditions are met:
The target business is in the same industry (same 6-digit NAICS code).
The target business is in the same geographic area (e.g., same metro region or county).
The exact same ownership structure applies to the purchased business.
Example: Your retail business buys another retail location in the same city with identical ownership—no injection needed.
If Conditions Aren’t Met: A 10% equity injection applies, like for a service business acquiring a location in a different region or industry.apply.
Equity Injections for Partner Buyouts
Partner buyouts involve purchasing a partner’s equity, either fully or partially, with specific equity injection rules.
Partner Buyouts:
Complete: Purchasing 100% of a partner’s equity, transferring their full ownership to you.
Partial: Purchasing part of a partner’s equity, with the seller retaining some ownership.
Equity Injection: The lesser of:
10% of the purchase price.
An amount ensuring a debt-to-worth ratio of 9:1 or lower on the pro forma balance sheet (based on the most recent fiscal year and quarter).
Exemption: No injection is required if:
The buyer has been an active operator and owned 10% or more of the business for at least 24 months, verified by both buyer and seller.
The business maintains a debt-to-worth ratio of 9:1 or lower (total debt ÷ total equity).
Sources: Must be paid in cash, seller notes for partner buyouts for the purposes of the equity injection are ineligible.
Guarantors: Post-sale, owners with 20%+ equity (including the seller, if retaining equity) must provide a personal guaranty. Sellers retaining less than 20% must guarantee the loan for 2 years post-disbursement.
Calculating the 9:1 Debt-to-Worth Ratio
What It Is: Measures financial health by comparing total debt to total equity (owner-invested capital). A 9:1 ratio means $9 in debt per $1 in equity.
Calculation: Divide total debt by total equity on the pro forma balance sheet (post-transaction).
Example: $900,000 debt ÷ $100,000 equity = 9:1 ratio, meeting the threshold. If debt is $1 million, a $111,111 injection reduces it to 9:1 ($1,000,000 ÷ $111,111 ≈ 9).
Why It Matters: A ratio above 9:1 signals financial risk, requiring a larger injection to stabilize the business, such as for a service or retail buyout. LoanBox helps you calculate and document this ratio for lender approval.
Minimizing Cash Down Requirements with Strategic Financing
By leveraging these strategies, you can minimize upfront costs and position yourself for successful acquisitions while maximizing your financial flexibility.
Buying a Book or Practice
Reducing Equity Injection to 5%:
If you’re purchasing assets and don’t qualify for an expansion loan, the standard SBA requirement is a 10% equity injection. However, this can be reduced to 5% with a seller promissory note. The SBA allows sellers to issue a standby seller note, with no principal or interest payments required during the full term of the loan (typically 10 years). Interest may accrue, but payment is deferred until the loan matures. To take advantage of this, discuss the standby note with the seller early in the process and secure their agreement, reducing your cash requirement significantly.
Buying Equity in a Practice
How to Avoid an Equity Injection (0% Down):
You can eliminate the need for an SBA equity injection in two scenarios:
Established Ownership: If you’ve been an active operator with at least 10% ownership in the business for over 24 months, SBA equity injection requirements do not apply. Verification is required, typically through tax returns, but processes may vary by lender.
Strong Financial Ratios: If the practice you’re buying into has a debt-to-worth ratio of 9:1 or better (e.g., $900,000 in liabilities to $100,000 in equity), no equity injection is needed. This could be as simple as the business having little to no debt. Confirm the debt-to-worth ratio in advance to ensure eligibility.
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