SBA’s New Partner Buy-Out Rules

Victor Diaz, Managing Partner of Starfield & Smith’s Florida office

Starting April 1, the SBA is changing its rules for financing partner buyouts, and GABB affiliate Susan Kite has provided a more detailed explanation of the changes. Kite, a Vice President and SBA Business Development Officer at Renasant Bank, says that the new SBA rules are designed to prompt borrowers to put more of their own cash money to finance partner buy-outs. SBA loans are frequently used in the purchase of businesses.

Victor A. Diaz, an attorney who is Managing Partner of Starfield & Smith’s Florida office, wrote in a recent client newsletter that the SBA tweaked its 7(a) lending program “as part of its overall goal of increased oversight and enhanced performance of its portfolio.”

The new rules “require greater use of cash (rather than debt) to finance partner buyouts.”  In the regulation labeled SOP 50 10 5 (J), the SBA described “mandatory minimum cash equity injections from borrowers for loans used to finance changes of ownership.”

Earlier, the SBA issued a notice to prevent lenders from financing “more than 90% of the business purchase price or finance the acquisition of a partner’s interest who had not been sufficiently active in the business.” Under SOP 50 10 5 (K)  effective April 1, 2019, the SBA has added two requirements before a borrower may finance more than 90% of the purchase price of a partner buyout. The two new requirements, according to Mr. Diaz:

(a) The remaining owner(s) must certify that he/she has been actively participating in the business operation and held the same ownership interest in the business for at least the past 24 months (Lender must include in the credit memorandum confirmation that the Borrower has made the required certification and retain such certification in the file); and

(b) 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.

Mr. Diaz writes that “in the event the Lender is unable to document that both (a) and (b) above are satisfied, the remaining owner(s) must contribute cash in the amount of at least 10% of the purchase price of the business, as reflected in the purchase and sale agreement. SOP 50 10 5 (K), page 185.”

Because of this change, “the need for additional cash equity will be assessed not on a forward-looking, pro-forma basis,” Mr. Diaz writes. “Instead, prior to the change of ownership, the business must demonstrate it is not over-leveraged. If the financial evaluation does not meet this threshold, additional cash equity will be required from the borrower in the amount of 10% of the purchase price, which reduces the possibility of the borrower utilizing debt rather than cash to finance the partner buyout.”

The SOP 50 10 5(K) will become effective April 1, 2019, and will apply to all applications received by SBA on or after that date. For more information on changes of ownership, please contact Victor at vdiaz@starfieldsmith.com or at 407.667.8811.

Thanks to Susan Kite for updating us on this rule.