A recent technical change in the Small Business Administration’s (SBA) lending policies could make it easier to finance buying out a business partner. Prior to this change, borrowing money to buy out a partner through an SBA loan guarantee program could often be difficult or impossible.

In the past, the fact that the partner buyout process left many businesses with negative equity made it extremely difficult to use SBA 7(a) loans for partner buyouts without needing to contribute a large amount of cash into the company.

Passed last year, the new SBA rules state that the borrower does not need to put down any equity as long as the business has a debt-to-net-worth ratio below 9:1. If the ratio is greater, the borrower will have to contribute 10% equity to qualify for the loan. (For a detailed example, consider this helpful article.)

Keep in mind that the SBA does not actually make loans — it offers to guarantee a portion of loans made by lenders that qualify under its various programs. Under the SBA 7(a) program, the maximum permitted loan is $5 million, of which the SBA may guarantee up to 75%.

Restrictions and Rules

Like most governmental programs, SBA loan programs come with many restrictions and rules. When buying out a partner, some of the most important things to know include:

• Partial buyouts cannot be financed by SBA loans — the buyer is required to purchase 100% of the business. This requirement also applies if existing partner(s) are buying out other partner(s) of the business.
• The seller may not remain involved with the company as an owner, officer, director, or employee.
• If a transitional period is needed after the sale, the seller may serve as a paid consultant for up to 12 months, but not for longer.

There are many other rules to consider — talk with your banking and financial advisors.

What If the SBA Is Not for You?

There are many situations where the SBA is not a solution if seeking to buy out a business partner. The following conditions likely preclude you from using an SBA program:

• The selling owner(s) want(s) to keep some equity in the company, or stay involved in the company post-sale, such as serving on the board.
• You need to borrow more than the SBA 7(a) program maximum of $5 million.
• You are concerned about overloading the company with debt.
• You are concerned about personally guaranteeing the debt, which is usually required.

Many business owners are unaware of other methods to finance buying out a business partner, including bringing in non-controlling equity investors. It is important to carefully explore and weigh all of the options, and therefore work with advisors experienced in situations like yours.

To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.

Owning a business is one of the greatest pleasures and accomplishments of your life. You enjoy the freedom it has brought you, the opportunity to overcome its constant challenges, and the lifestyle it has afforded your family.

Through your business, you’ve created jobs, served employees and customers, innovated your market, and accomplished more than you could have dreamed when you first started. You are proud to be a business owner.

Yet there is a secret you keep, one you feel you cannot share with your trusted employees and valued customers. You probably have not openly discussed it with your spouse and family. Perhaps you have not said it aloud to yourself. Your secret is that one day, before it gets too late, you want out of the business. At some point, you want to exit.

Your Exit Will Happen One Day

So there it is. You want to exit. Just hearing the words may bring a range of emotions: fear, excitement, uncertainty. You love what you do and are immensely proud of the business and its people. Yet one day you will want to move on.

It is not that you are unhappy. You are happy. It is not that you want to retire. Perhaps you don’t — you enjoy working and growing the business. The day is coming, however, when you can see that you will want to do something else. You have other interests and ideas that you want to pursue without feeling guilty about not giving your business your fullest attention.

Perhaps you sense the day is coming when the business will be better served by a new generation, one with the talent and passion to take what you built to an even higher level. You want the business to be in good hands after it leaves yours.

Your exit will not be tomorrow, but it will happen one day. Many owners will spend 10 or more years telling themselves they want to exit in the next five years. Maybe for you it is finally time to stop rolling things indefinitely forward.

Dealing With the Unknowns and Questions

You have spoken about this subject with hardly anybody. There are too many unknowns, too many people impacted. What will happen to your employees? How will your customers be treated? What will people say about the business after you are gone? How will things change with your family if you don’t have the business anymore? What will be the financial impact to them?

It’s not just about other people. What about you? How will you feel about yourself? Your sense of identity is rooted in your business. It defines you. We live in a culture where the most common first question we ask new people in social settings is, “What do you do for a living?” You are proud to answer that you own and lead a business. How will you answer that question after you exit? Who will you be then? What will your life be if you don’t have an office to go to every day?

You have run your business honestly, always trying to be transparent with employees, customers, and business partners. On this topic, however, you feel you cannot talk to those people. You don’t know how they will react. You have heard horror stories of competitors poaching employees and customers when the word gets out that a company might be for sale, even long before it actually is for sale.

Your business is built on relationships. What will happen if customers, lenders, and suppliers learn that you may not be around for the longer term? So your desire to exit one day remains your secret. While you know intellectually that exiting one day is no different than any regular employee’s expectation of retiring one day, sometimes it can feel like a dirty secret. That’s not how you do business — keeping secrets and wrestling with big questions for which you don’t have answers.

A Better Way to Exit Does Exist

This issue is too important. Your financial security is tied up in your business. You care about and respect the people impacted by your future exit and dislike not being up front with them. You feel like there are some conversations that you need to have, and soon. But you have no idea exactly who to have them with, how to have them, when to have them, and when not to.

You have heard how difficult, stressful, expensive, and risky it is to exit from a business. Your instincts tell you that trying to do it alone, without getting help and not being up front with these people, is a bad plan. There must be a better way.

If you want the option of successfully and happily exiting within the next five years or sooner, it may be time to get your exit plan in place. To get started, download our complimentary ebook, “Your Last Five Years: How the Final 60 Months Will Make or Break Your Exit Success.”

To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.

Take the Money Home This Year! (7 Reasons Why Business Owners Need to Withdraw More Money Out of the Company Prior to Exit)

Every time a business generates an extra dollar of profit, the business’s owner has a choice to make — do you leave that money in the business to reinvest, or receive it personally and take it home?

We call this the reinvest-receive ratio. The entrepreneurial habit is to leave most money in the business. Reinvesting in the business can make a lot of sense. In the beginning, when a business may be small and fragile, reinvesting might be required just to survive.

Once the business is established and expanding, reinvesting back into the business often seems like a no-brainer decision — the company is your investment with the greatest potential for growth. As a result, business owners tend to reinvest most of their dollars over time, to the point where they end up with the vast majority of their personal net worth sitting inside their companies by the time they reach exit.

7 Advantages of Taking Surplus Dollars Out

However, as exit draws near, reinvesting heavily or even exclusively back into the business can cause problems. In our experience, there are seven important advantages owners gain by taking surplus dollars out of the company prior to exit.

1. 1. Receiving dollars reduces risk. We are all familiar with the dangers of putting all your eggs into one basket. Business owners are not exempt from this risk. Warren Buffett, someone well-versed in creating wealth through business, once observed, “You can get rich by only investing in one stock, but you can’t stay rich that way.” In addition, cash left in the business is also exposed to potential business creditors.
2. 2. Taking dollars home can, in some situations, reduce current income taxes. There are several ways owners can receive money from the business along the way and in the process reduce current income taxes. For example, retirement plans and captive insurance companies are two strategies that potentially can create tax-favorable wealth accumulation for the owner outside the company.
3. 3. Taking money out of the company increases exit options. Owners who have predominantly reinvested back into the business typically need cash at exit because they have little to none outside the company. The serious need for cash can eliminate exit options, such as giving the business to the kids. Selling the business to an inside buyer (one or more employees) also may be prohibitively difficult. Receiving money from the business prior to exit increases the owner’s exit options.
4. 4. Withdrawing surplus money increases control over the exit timing. Owners who have 50%, 75%, 90%, or more of their net worth tied up in their business sooner or later feel stress and pressure to fully or partially cash out. Receiving money from the business along the way reduces dependency and stress while increasing control over choosing when to exit.
5. 5. Next, receiving dollars personally helps increase your control over your future exit terms. When selling a business, owners who need a large portion of cash at closing may be unable to consider deal terms such as installment sales, stock swaps, and other terms that feature less cash at closing but offer potential advantages such as potential tax savings. Receiving money from the business along the way maximizes flexibility at exit.
6. 6. Last, taking surplus dollars out of the company can reduce co-owner conflict. When a business has two or more owners, it is nearly inevitable that the owners will have some incompatible exit goals, no matter how well they get along. One owner may want to exit sooner than another. Or, one owner may want to sell, while another owner wants his or her kids to get the business. When business co-owners have reinvested heavily back into the business, any competing exit goals will directly undermine one another’s success. Receiving money from the business along the way reduces potential co-owner conflict and goal misalignment.
7. 7. Taking surplus cash out of the company helps reduce the risk that you and your company’s buyer (if you intend to sell the business) disagree about how much cash is needed to run the company. This issue, often called the working capital adjustment, can be a serious problem at sale if your buyer wants you to leave more money in the company, thereby reducing your take-home proceeds at sale.

When to Design a Formal Exit Plan

If your desired exit is five years or sooner, it is time to design and follow a formal exit plan. Owners and their advisors need sound financial systems and forecasts to help them determine how much cash really is needed to fuel the business’s growth needs.

Any cash not needed for the foreseeable future should be received by the owners to diversify their net worth and avoid the pitfalls that can otherwise happen at exit. Remember, if later you realize you took too much cash out, you can always put it back in, but the reverse is not true.

To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.