SBA Loan Rule Change Revolutionizes Small Business Acquisitions
The landscape of small business acquisitions has undergone a significant transformation with a recent change in the Small Business Administration (SBA) 7(a) loan program rules. Previously, acquiring a business using this loan, which offers financing up to $5 million, mandated purchasing 100% of the company. This restriction hindered small business buyers from employing a common private equity tactic: offering existing owners and key personnel continued equity in the company post-acquisition. This limitation often resulted in the loss of valuable institutional knowledge and hindered smooth transitions, as buyers were unable to fully leverage the expertise of those who built the acquired businesses.
In a move to address this issue, the SBA initially allowed sellers to retain up to 20% equity after the sale, incentivizing smoother handovers without requiring personal loan guarantees. However, this only applied to equity deals, excluding the preferred asset deal structure. Equity deals involve purchasing the entire company, including its liabilities, while asset deals allow buyers to selectively acquire desired components, such as equipment and customer lists, while leaving behind unwanted liabilities.
The SBA further expanded its regulations in December 2024, permitting buyers to structure acquisitions as asset deals while still allowing sellers to retain up to 20% equity. This change empowers buyers to strategically select acquired assets, mitigate liability risks, and retain the previous owner’s expertise during the transition. This strategy, long employed by private equity firms, now provides small business buyers with greater flexibility and control in structuring acquisitions. The SBA’s objective with this change was to accommodate partial ownership changes, enabling the formation of new entities to own the operating company, often for tax or liability protection.
This new rule offers several advantages for buyers. They can now leverage equity as part of the purchase price, reducing borrowing requirements, and retain the seller’s involvement for a smoother transition. This approach mirrors practices common in private equity transactions, allowing for the continued engagement of founders and key employees, lending a more sophisticated dimension to small business acquisitions. Previously, sellers were limited to a 12-month transition period, regardless of their willingness to stay longer. The attractiveness of the SBA 7(a) program, with its relaxed lending requirements like personal guarantees replacing collateral and extended repayment terms of up to 25 years, often outweighed these limitations. However, under the new rules, this restriction no longer applies as the seller’s involvement is within a newly formed entity.
The mechanics of asset deals under the new rule involve the buyer establishing a new entity, acquiring the old business’s assets, and granting the seller equity in the new entity as part of the payment. This allows the seller to receive immediate cash while retaining an equity stake with potential future growth. Since anyone holding 20% or more of a 7(a)-financed business must personally guarantee the loan, sellers generally maintain their stake below this threshold, often significantly lower, as the lender has discretion over guarantee requirements. This differs from mid-market private equity transactions where minority investors rarely provide personal guarantees.
Prior to the latest change, buyers were restricted to equity deals, a constraint many found frustrating. Asset deals are often preferred due to their ability to isolate buyers from previous company liabilities. With the initial SBA rule change, equity transactions increased from 10% to around 40% of advised deals, indicating buyer interest despite the imperfect arrangement. However, equity-based structures carry risks, as illustrated by a case where a buyer inherited regulatory issues that threatened a significant portion of the company’s revenue and exposed it to potential fines. An asset deal would have avoided this inherited liability.
While the new rule enables small business buyers to utilize rollover equity strategies akin to large private equity firms, it’s crucial to consider the implications of retaining the previous owner. Maintaining a positive working relationship is essential, as personality clashes can lead to conflicts. Implementing a buyback mechanism for the seller’s equity can mitigate potential issues arising from strained relationships. Without such a mechanism, buyers could be burdened with an unwanted partner or an obstructive founder, potentially leading to lawsuits, revenue loss, and significant operational challenges.
The most common pitfall in partial buyouts arises from the seller’s difficulty adjusting to a non-leadership role, leading to internal conflicts. Careful consideration and planning are crucial to successful implementation of this new acquisition strategy. While offering continued equity can be a powerful tool for ensuring a smooth transition and leveraging the previous owner’s expertise, it’s important to address potential complications proactively. A well-structured agreement with clear roles, responsibilities, and exit strategies can significantly reduce the risks associated with this innovative approach to small business acquisitions.
