Best Practices: Change of Ownership – Partner Buyouts

As part of its overall goal of increased oversight and enhanced performance of its portfolio, the SBA has tweaked its flagship 7(a) lending program. In an effort to encourage borrowers to put more skin in the game, the rules require greater use of cash (rather than debt) to finance partner buyouts. In the SOP 50 10 5 (J), the SBA introduced the concept of requiring mandatory minimum cash equity injections from borrowers for loans used to finance changes of ownership.

In order to assure that lenders did not finance 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, the SBA published Policy Notice 5000-14057 in April 3, 2018. The guidance promulgated under this policy has been incorporated formally into the new SOP 50 10 5 (K) which will become effective April 1, 2019. Under the new SOP, in order to finance greater than 90% of the purchase price of a partner buyout, the SBA has introduced two additional requirements:

(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.

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, Emphasis added.

As a result of this change, the need for additional cash equity will be assessed not on a forward-looking, pro-forma basis. 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.

For more information on changes of ownership, please contact Victor at vdiaz@starfieldsmith.com or at 407.667.8811.