LOANOLOGY

SUCCESSION LENDING

Planning for business succession is a critical step for small business owners and franchisees looking to transition ownership, whether through partner buy-ins or complete buyouts. SBA loans offer flexible financing options for these transitions, but they come with unique requirements. With the updated SBA SOP 50 10 8 (effective June 1, 2025), LoanBox simplifies succession lending, helping you navigate equity buy-ins and buyouts efficiently. Below, we outline key considerations and strategies to achieve a seamless ownership transition.

Equity Buy-in Loans

Equity buy-in loans allow partners or employees to purchase a stake in a business, facilitating gradual succession. These loans, available through SBA and conventional lenders, have distinct rules for guaranties, collateral, and equity injections.

What Partners with 20%+ Ownership Need to Know

  • SBA Loans:

    • Guaranty Requirements: Owners with 20% or more ownership must provide an unlimited personal guaranty, covering the full loan amount, interest, and collection costs, per SOP 50 10 8.

    • Collateral: For loans over $500,000, if business assets are insufficient, lenders may require personal real estate with 25% or more equity as collateral. A Home Equity Line of Credit (HELOC) can reduce equity below 25%, avoiding a lien. For loans $50,000 or less (e.g., Express loans), collateral may not be required.

    • Lien on Business: A blanket UCC lien is placed on the entire business, encompassing all assets (current and future), even for partial buy-ins. This lien remains for the loan’s duration, affecting all owners’ equity, including non-borrowing partners.

  • Conventional Loans:

    • Guaranty Requirements: Non-borrowing partners with 20% or more ownership typically sign a corporate guaranty or grantor agreement, pledging business collateral to the lender. Personal guaranties are less common but may be required case-by-case, depending on the borrower’s financials and loan risk.

    • Lien on Business: Similar to SBA loans, a lien covers the entire business, impacting all owners’ equity.

  • Why It Matters: Understanding guaranty and lien obligations ensures all partners are prepared for the financial commitment, and LoanBox matches you with lenders whose policies align with your needs.

Comparing SBA and Conventional Equity Injections

The equity injection—cash down payment or seller financing required for the loan—varies significantly between SBA and conventional loans.

  • SBA Equity Injection (0% or 10%):

    • 0% Injection: Waived if the new owner contributes at least 50% of the business’s equity post-transaction, per SOP 50 10 8, or if the business maintains a debt-to-worth ratio of 9:1 or lower (total debt ÷ total equity, based on the most recent fiscal year and quarter).

    • 10% Injection: Required for partial or complete buyouts if the 9:1 ratio is exceeded or the 50% equity condition isn’t met. Seller financing is permitted (subordinated to the lender) but cannot replace the full 10% cash requirement.

    • Example: For a $1 million partial buy-in, a $100,000 cash injection is needed unless the business’s debt-to-worth is 9:1 or the buyer owns 50%+ equity.

  • Conventional Equity Injection (Typically 25%):

    • Conventional lenders cap loan-to-value (LTV) at 75% (some up to 85%), requiring a 25% equity injection via cash or seller financing.

    • LTV Calculation: Combines the buyer’s and seller’s business values. For a $1 million acquisition, if the buyer’s business is valued at $333,000 and the seller’s at $1 million, LTV = $1 million ÷ $1,333,000 = 75%, meeting the threshold. The buyer’s value must be at least 33% of the seller’s to avoid exceeding 75% LTV.

  • Why It Matters: SBA loans offer lower injection requirements, increasing accessibility, while conventional loans demand higher upfront capital. LoanBox helps you structure injections to meet lender standards.

Complete and Partial Partner Buyouts

Complete Partner Buyout

A complete buyout involves purchasing a partner’s entire ownership stake, fully transferring their equity.

  • SBA Requirements:

    • 10% Equity Injection: Mandatory unless:

      1. The borrower has been an active operator and owned 10% or more of the business for at least 2 years, verified by both borrower and seller.

      2. The business maintains a debt-to-worth ratio of 9:1 or lower, calculated from the most recent fiscal year and quarter balance sheets.

    • Guaranties: Remaining owners with 20% or more equity must provide unlimited personal guaranties.

  • Why It Matters: Meeting these conditions reduces cash requirements, and LoanBox ensures your application reflects compliance with SBA rules.

Partial Partner Buyout

A partial buyout involves purchasing a portion of a partner’s equity, allowing phased succession.

  • SBA Requirements:

    • 10% Equity Injection: Required unless:

      1. The business maintains a debt-to-worth ratio of 9:1 or lower.

      2. Remaining owners with 20% or more equity comply with SBA guaranty and collateral requirements, including personal guaranties and potential real estate pledges (25%+ equity for loans over $500,000).

    • Guaranties: All owners with 20% or more equity, including non-borrowers, must provide guaranties, ensuring shared liability.

  • Why It Matters: Partial buyouts enable gradual transitions, and LoanBox matches you with lenders flexible on guaranties and injections.

Understanding the 9:1 Debt-to-Worth Ratio

The 9:1 debt-to-worth ratio is a key SBA metric for waiving equity injections in partner buyout loans, assessing financial stability.

  • Calculation:
    Total Debt ÷ Total Equity = Debt-to-Worth Ratio

    • Total Debt: All business liabilities (e.g., loans, accounts payable) from the most recent fiscal year and quarter.

    • Total Equity: Owner-invested capital and retained earnings.

    • Example: A business with $900,000 in debt and $100,000 in equity has a ratio of $900,000 ÷ $100,000 = 9:1.

  • Interpretation: A ratio of 9:1 or lower indicates lower financial risk, allowing a 0% equity injection. Ratios above 9:1 require a 10% injection to demonstrate stability.

  • Why It Matters: A favorable ratio reduces upfront costs, and LoanBox helps optimize your financials to meet this threshold.

Succession Equity Buy-ins: A Staged Approach

For owners planning to transition out gradually, LoanBox offers a structured approach to succession through staged equity buy-ins, leveraging SBA rules to achieve full ownership over time without requiring seller guaranties. This strategy, while not an official SBA program, aligns with SOP 50 10 8 for partial buyouts, ensuring a DSCR of 1.15+ and a debt-to-worth ratio of 9:1 or lower.

  1. Initial Minority Equity (<5%):

    • A small equity stake (e.g., 5%) is transferred to the successor, paid via cash, services rendered, or converted phantom stock.

    • An SBA loan can finance this, but all owners with 20% or more equity must provide guaranties, including the seller if they retain 20%+.

  2. Two-Year Waiting Period:

    • The successor receives K-1 distributions for at least 2 years, establishing operational involvement. This satisfies SBA’s active operator requirement for future buyouts.

  3. Majority Equity Purchase (76%–94%):

    • After 2 years, the successor can pursue SBA financing for a partial buyout of 76%–94% equity, leaving the seller with 1%–19%.

    • No seller guaranty is required, as the seller’s ownership falls below 20%. Remaining owners with 20%+ equity provide guaranties.

    • The deal must maintain a DSCR of 1.15+ and a debt-to-worth ratio of 9:1 or lower.

  4. Final Equity Transfer:

    • The seller retains a minority stake (1%–19%) until ready to retire, selling the remaining equity in one transaction or smaller tranches, per the partnership agreement.

    • Financing for this stage follows standard SBA buyout rules, with a 10% equity injection unless waived.

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