The Ins and Outs of Partner Buyout Financing

There comes a time in many businesses with multiple owners where one or more of the owners would like to exit the business. Typically, this can be a result of any number of reasons; however, the issue become the buyout of the partner.  How much is the business worth? Is there financing for this? What can a bank help me with? In many cases, partners may agree to a Seller Note.  This is simply a promissory note that one partner pays to the other over time, very similarly to bank debt.  For example, two partners own a local hardware store, located in a strip center, and one would like to exit and focus on other opportunities. With the absence of hard collateral (no real estate owned) and not enough cash on hand, the owners find that local banks are unwilling to lend for this transaction.  Thus, the two partners, with the help of an attorney, agree that one-half of the business is worth $250,000 and set up a promissory note for 10 years at an interest rate of 5%. This setup is typically more advantageous to the buying partner as he is able to stretch his payments out over a long period of time, while letting the future cash flows of the business pay for the buyout.  On the other hand, in our example, if the business did own assets, such as real estate, with enough equity a lender might provide a real estate secured loan that could then be used to pay the exiting partner.

Another solution that has become increasingly popular is an SBA 7a loan.  The SBA provides a 75% loan guarantee for banks executing these loans. So, this is a loan from a bank, not the SBA; the bank simply has a ¾ guarantee on it’s loan from the goverenemtn, which incentivizes the bank to make riskier and undersecured loans.  For instance, in our previous example, if the hardware owners approached a bank for 7a financing, this loan would easily qualify. The selling owner, post closing, would receive his money immediately, while the buying owner would have a 10-year term note to the bank, at a similar interest rate.  Are there some downsides to the SBA loan? Typically there would be upfront fees (which can be financed), and the buying owner would need to put 10% into the transaction with cash (5% is allowed; however, a subordinated, seller note to the bank note would be needed for the other 5%).  There are some other restrictions; however, the selling partner may prefer to receive all of his money upfront, and more negotiations on the selling price could be had based on this factor.  

Thus, if you find yourself without hard assets and in need of buyout financing, the SBA provides a great program that will allow you to do this, without bringing on additional investors or debt at outrageous interest rates.