The key to minimizing the lender’s perceived risk in financing the transaction.
If you decide the best scenario for you is to transfer
ownership of your business to management or family,
more often than not you will need some combination of
bank financing and seller financing. The buyer’s goals most
likely will be to minimize their personal out of pocket equity
contribution and to maximize the amount borrowed. This
approach not only covers their buy in, but also can provide
additional working capital to accomplish new growth
strategies and cover closing costs associated with the
The key to executing this approach is to minimize the
lender’s perceived risk in financing the transaction.
Admittedly banks are in the risk business; however, there are
strategies that seller and buyer can collaboratively employ
to minimize the risk of a particular transaction. One way to
mitigate risk for the bank is for buyer/borrower to utilize
the SBA 7a Government Guaranteed lending program.
The SBA 7a lending program can be used to facilitate the
purchase of businesses. While there are restrictions on the
size and type of companies that qualify, as well as limits on
the net worth of guarantors, the program does allow for
up to a 75% government guarantee to participating banks
on loans up to $5 million. SBA 7a loans have more flexible
repayment terms and can be used to finance an acquisition
of an entire business, infuse the company with additional
capital for growth, purchase new equipment and/or real
estate, and to cover closing costs associated with the loan.
If you are looking to sell your company to key employees
or family, a possible strategy for overcoming the down
payment/equity injection requirement is to create an
ownership-based management incentive program.
Under this program you can transfer a percentage of
the stock to key employees based on achieving certain
performance metrics. A stock based incentive plan will
provide a strong incentive to key management.
Another strategy is to allow key employees or family to buy
a portion (20%-30%) of the company in advance of selling
the entire company. The purchase price of the stock could
be offered at a significant discount to allow the acquiring
shareholders to buy-in at a favorable price using personal
resources. If the buyers do not have sufficient resources
for the buy-in, the company or selling shareholder could
provide some or all of the financing that is needed.
A dividend policy could be implemented so that distributions
are sufficient, after taxes, to repay the loan in full over a
reasonable period of time. Prior to SBA7a financing being
allowed to fund your complete exit from the business, any
loans to finance the partial buy-ins would need to be repaid.
Since key management or family would then own at least
20%-30% of the business, this scenario would typically meet
the lender’s down payment requirement and the Buyer(s)
could then borrow the rest of the money via an SBA 7a loan
to cash you out entirely.
To execute on this plan, several criteria will need to be
met. Probably most important, a capable and competent
management team will need to be in place. Additionally,
there cannot be excessive leverage on the business and
cash flow needs to be sufficient to repay the loan, as well
as provide for ongoing operations and growth of the
company. If you ask bankers what makes a good loan, most
will respond that a good management team is needed as
one of their top answers.
In order to finance a purchase transaction by a management
team or family, the bank will assess their capabilities. If a
good management team is not in place, it will not only hurt
the value of your business, it will get in the way of financing
an ownership transfer transaction. The key to any successful
transition is to plan appropriately and implement strategies
well in advance of the transition event. Having a strong
advisory team, along with a good banking relationship will
help ensure a successful transition.
© Chuck Owston, CM&AA, CEPA, Florida Capital Advisors