Unfortunately for borrowers, SBA 7(a) loans cannot be used to purchase part of a business. Partial equity, earn outs, and employment arrangements are also generally prohibited. In addition, due to the SBA’s ban on employment arrangements, the seller may not stay on as a director, officer, shareholder, or essential employee of the business that they are selling. However, an SBA loan borrower is permitted to offer the seller a consulting agreement, but that agreement may not last any more than 12 months.
Earn Outs Are Prohibited Under SBA Rules
Earn-outs, which are not permitted under SBA loan regulations, involve the seller of a business staying with it for prearranged period, usually a few years, during which they will receive additional payments based on the financial performance of the company. In theory, this will incentivize the seller to make sure the company successfully transitions to new ownership, but in practice, it could lead to conflicts that undermine the stability of the business.
Seller Notes Can Help Bridge the SBA Financing Gap
While earn-outs are no longer available to SBA loan borrowers, borrowers can use a seller note to finance up to 5% of the purchase price of a business. Under the SBA’s new rules, business acquisitions can be financed up to 90% by a lender. Combine this with a 5% seller note, and borrowers can purchase a business with as little as 5% down.