The Small Business Administration (SBA) has recently made a significant change to the equity injection requirements for their loan programs. The SBA will now allow up to 50% of the equity injection (buyer down payment) to be provided in the form of seller financing. Seller financing is when the seller provides a portion of the financing to the buyer to help with the purchase of the business.

Here’s the actual SBA Guideline:

Traditionally, the equity injection requirement for SBA loans has required the buyer to provide a non-borrowed* down payment of 10%, but can be 0% in some partner buyouts and as high as 20% of the total purchase price if the lender has concerns about the strength of the buyer or business.

This change to allow a component of the down payment (which the SBA refers to as “equity injection”) to be credited from seller financing can greatly benefit both buyers and sellers in the acquisition of a small business.

Seller Pro’s: For sellers, this change can make their business more attractive to potential buyers. By offering any form of seller financing, the seller can show that they have confidence in the future success of the business and are willing to help the buyer with the initial investment needed. This can make the business more desirable to buyers who may not have the full cash down payment readily available or to those that do have the required down payment but prefer to preserve their capital thereby enlarging the viable prospective buyer pool.

Buyer Pro’s: For buyers, this change allows them to preserve their own cash reserves and reduce the amount of investment needed to purchase a business. This can make it easier for buyers to secure financing and can be especially helpful for those who may not have access to the required cash down payment.

Seller Con’s: The primary concern among sellers being asked to provide seller financing to be used as buyers equity injection are the mandated terms of the SBA for it’s qualification being that the note be on full standby for the full term of the SBA loan. This term is a full decade unless the borrower chooses to pay the note off in full early or the business is sold within the 10 year period.

Buyer Con’s: As in all negotiations when one party requests something the other party typically does as well so when asking a Seller to put up to 50% of the equity injection in the form of seller financing on full-standby for 10 years the seller is very likely going to expect a higher than typical sales multiple. While the interest rate on the equity injection seller financing is not mandated by the SBA, 10 years of compounding interest can make the lump sum payment due in 60 months significant.

It is important to note that seller financing still needs to be disclosed and accounted for on the buyer's financial statements. Virtually all forms of seller financing require the buyer to execute a personal guarantee and UCC filing for the benefit of seller.

Overall, the change to allow seller financing as part of the equity injection for SBA loans can be a valuable tool for small business buyers and sellers. It can help make small business acquisitions more accessible and desirable for both parties involved. As with any financing option, it is important for buyers and sellers to carefully consider the terms and conditions of the seller financing and to work with experienced business intermediaries, transaction attorneys, and tax advisors to ensure a successful transaction and long-term outcome.

*Some exceptions do exist such as a qualified ROBs plan, having partners who appear on the CAP table and co-guarantee the commercial 7(a) business acquisition loan, and borrowed cured funds. For more information on these options contact an experienced business intermediary for more details.