What is an acquisition equity Injection?

What is an equity injection? An equity injection represents the borrower and in a way the seller's "skin in the game" for an acquisition loan. It indicates the infusion of either cash or assets into a deal to reduce the leverage of an asset or equity purchase. This injection can come from the buyer as a cash down payment, or a seller can contribute equity by providing a promissory note for a portion of the purchase price. Equity injections can therefore be satisfied through the buyer's down payment, with a seller’s note, or in some combination.

Conventional loan down payment for an acquisition?

Equity Injection With Conventional Loans While a borrower’s personal financial situation and credit profile have influence, the primary equity injection criteria from conventional lenders focus on the Loan-to-Value (LTV) ratio. Typically, conventional lenders cap LTV at 75%, although some may extend to 85%.

For acquisitions, LTV is calculated by combining the value of the buyer's and seller's practices, resulting in most conventional acquisition deals meeting the LTV requirement. If a $1M value practice acquires a $1M value practice then $1M loan/$2M value = 50% LTV.

When a $333,000 value practice acquires $1M value practice then $1M/$1,333,000 = 75% LTV. In this case an equity injection (down payment and/or seller financing) is not required based on LTV but the lender may have other reasons they may want to see "some level" of injection (5%-10%).

Rule of thumb if both practices valued at same multiple, the buyer’s value needs to be at least 33% of the seller’s value (or visa-versa) to meet a 75% LTV.

What is the SBA equity injection about?

Change of Ownership Loans These loans entail acquiring a business, assets, or equity, where the ownership is entirely transferred from the seller to the buyer. These loans include new business purchase loans, expansion business purchase loans, and complete and partial partner buyouts.

In terms of Equity Injection for a Business Purchase, there are three ways to meet the equity injection requirement: 10% Cash, Full Standby Note, and Partial Standby Note. If choosing a Standby Note, the borrower will have two loans: an SBA loan with the lender, and a promissory note with the seller.

For changes of ownership resulting in a new owner (complete change of ownership): At a minimum, SBA requires an equity injection of at least 10 percent of the total project costs, (all costs required to complete the change of ownership, regardless of the source of funds) for such transactions.

What are change of ownership loans? A loan resulting in a change of ownership is when you are purchasing a business, assets or equity, whereby 100% of the ownership transfers from the seller to the buyer.

These include:

A new business purchase loan

An expansion business purchase loan

And complete and partial partner buyouts.

Expansion acquisitions don't require a down payment?

No down Payment Business Expansion Loans Business Expansion Loans do not require an equity injection. When an existing business starts or acquires a business that is in the same 6-digit NAICS code with identical ownership and in the same geographic area as the acquiring entity and they are co-borrowers, SBA considers this to be a business expansion and not a new business.

Expansion Acquisition When an existing business purchases another established business.

There is no down payment requirement for one business purchasing another business if three conditions are met.

1 - The target business to purchase is in the same industry

2 - The target business to purchase is in the same geographical area as your current business

3 - The exact same current ownership structure will be applied to the purchased business.

If all three of these conditions are met then no equity injection is required. If all three conditions are not met, then the ten percent equity injection rules apply.

What is the SBA’s acquisition 10% equity injection rule all about?

In 2018, the SBA made a significant change in acquisition loan down payment requirements. The SBA now requires for acquisition loans that 10% of the purchase price (not loan amount) must be provided in the form of equity. This equity can be satisfied in 3 ways: cash, assets other than cash, and standby debt (up to 50% of the 10% = 5%). If an advisor buyer has a practice that can be valued high enough (and most do) then it can be used as “assets other than cash.”

This is how most of our acquisition loans are done. If there isn’t enough buyer practice value to satisfy the equity injection, then the buyer would be required to either come up with 10% of the purchase price in cash, or 5% in cash if seller will finance 5% of the purchase price on a full standby promissory note.

What about down payments for non-expansion loans?

Non-expansion Acquisition Equity Injections Equity Injection If Cash Payment The equity injection can be paid by the borrower in cash, preferably wired to the lender a week or two before the loan closing. The money can come from savings, investments, a Home Equity Line of Credit (HELOC), or as a gift (with a gift letter as proof). Lenders usually require the most recent account statement for verification.

Full Standby Note The SBA made a big change to the full standby seller note. Now the seller can finance the full ten percent of the equity injection requirement.

No principal or interest can be paid during the first two years standby period.

This option enables the borrower to purchase a business with no money down.

Partial Standby Note A partial standby is where interest only payments can be made for the first two years but not principal payments.

The seller can finance up to 7.5% in a partial standby note.

The SBA requires 2.5% to come from a source other than the seller.

Adequate cash flow has to support the partial standby option.

What about down payments for equity buyouts and buy-ins?

Partner Buyouts & Partial Equity Buy-ins Equity Injections Partner Buyouts Loans

Partner buyouts (complete or partial) have unique equity injection rules, reflecting their operational impact.

Complete/Partial Equity Buyouts:

Requirement: The lesser of a 10% equity injection of the purchase price (e.g., $50,000 for a $500,000 buyout) or an amount to achieve a debt-to-worth ratio of 9:1 or lower on the pro forma balance sheet (based on the most recent fiscal year and quarter), unless exempted.

Exemption: No injection is required for complete or partial buyouts if:

The borrower has been an active operator and owned 10% or more of the business for at least 24 months, verified by both buyer and seller.

The business maintains a debt-to-worth ratio of 9:1 or lower (total debt ÷ total equity, e.g., $900,000 ÷ $100,000 = 9:1).

Sources: Cash (e.g., savings, Home Equity Line of Credit, gifts with a gift letter), seller financing on full standby (up to 50% of the injection, no payments for the entire 7(a) loan term), or independently appraised non-cash assets (e.g., equipment above net book value). LoanBox verifies sources with documentation like account statements.

Restriction: Seller notes must be on full standby and subordinated to the SBA loan, with no acceleration clauses. Partial standby notes with interest-only payments are not permitted.

Guaranties: Post-buyout, owners with 20%+ direct/indirect equity (including the seller in partial buyouts) must provide unlimited personal guaranties. Sellers retaining less than 20% equity must guarantee the loan for 2 years post-disbursement. For ESOP transactions, sellers retaining partial ownership must provide a full, unlimited guaranty regardless of percentage.

Example: A partial buyout of $500,000 requires a $50,000 injection (e.g., $25,000 cash + $25,000 seller standby note) unless the borrower has 24 months of 10%+ ownership and a 5:1 debt-to-worth ratio ($500,000 debt ÷ $100,000 equity), waiving the injection. The seller, retaining 10% equity, guarantees the loan for 2 years.

How is the 9:1 ratio calculated? Calculating the 9:1 Debt to Equity Ratio The 9:1 ratio for equity injection in SBA SOP for partner buyout loans is a measure of a business's financial health. This ratio compares the business's debt to its equity, which represents the amount of capital invested in the business by its owners. A lower debt-to-equity ratio indicates that the business has more equity and is less reliant on debt, while a higher debt-to-equity ratio suggests that the business is more heavily indebted.

Calculating the 9:1 Ratio: To calculate the debt-to-equity ratio, divide the business's total debt by its total equity. For example, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.

Interpretation of the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to be indicative of financial risk. When a business's debt-to-equity ratio exceeds this threshold, it may be required to inject additional equity into the business to demonstrate its financial stability and reduce the risk of default on an SBA loan.