Equity Infusion with Rollover Equity / Partial Buyout?

August 02, 2024

by a searcher in Boston, MA, USA

I'm working on live deal where the seller and broker have proposed a <19% rollover equity in lieu of a seller's note. The company is a C-Corp and I am getting more comfortable doing a stock sale, potentially taking advantage of 338h.

Based on Live Oak's partial change of ownership flyer, it seems like if the debt-to-worth ratio is no greater than 9:1 before the change of ownership, the equity injection may be waived.

Has anyone gotten a deal approved with this sort of structure (i.e. SBA 7a , <20% equity rollover, no equity infusion from searcher)? I'd imagine lenders still want to see buyer equity.

Thanks!

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Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

I have talked to many CPAs, lenders and even SBA 7a). on the Partial Change of ownership (PCO). I think there are many unknowns despite few deals approved. Here is what I have learned.
Hope others can correct it if wrong.
1) The transaction has to be a stock purchase of Seller entity ABC.
2) Seller must be retaining ownership of existing company ABC. Seller buying a % of buyer's Newco, which buys ABC shares, is not allowed.
3) Buyer CAN NOT buy shares of ABC from the shareholder.
4) Lender's $X and the Buyer's equity $Y goes into ABC first. Buyer gets certain number of shares (say QRS) of ABC for $Y.
5) Now ABC redeems seller's shares such that seller has 19% and Buyer's QRS shares equal 81% ownership of ABC.
6) At this point ABC will, most likely, have negative net worth.

Questions
a) 9:1 is measured after the new debt is layered. Is it after redeeming seller shares?
b) In most cases, post-funding balance sheet with new owners is prepared after the closing. Is the lender ok with that? I asked SBA. They said it is up to the lender. If the business is required to share balance sheet with customers or regulatory authority, will negative net worth create problem? Would the seller panic?
c) Does the seller fully understand that Buyer is getting 81% for small $Y? Do they know that their retained ownership has significantly lower value after debt comes on the balance sheet?
d) Can negative net worth be fixed with 338/336? If answer is Yes, who is picking up the tax liability? Where is the cash coming from if buyer equity is low/zero?

PE is known for financial engineering. Searcher class beats it hands down.
One other point. Lower equity and higher leverage mean lower price unless debt amortization decreases.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

Great question. Under the new SBA 7A partial business acquisition rules (even though about a year old now, they still feel new), you can buy into an existing company with no required equity from the SBA standpoint if they debt-t0-net worth ratio will be 9 to 1 or less. This is calculated by taking the current balance sheets from the past six months and layering in the new debt. Although technically zero equity is required in this situation, generally speaking we have not seen lenders willing to offer it at zero equity. Most still want to see the buyer(s) have some skin in the game. We recently got a deal approved under this situation at just over 2.5% equity and have done a couple of others at 5% equity. So there are lenders willing to do it with less equity. Generally speaking the deal has to make sense, the buyer has to be the right buyer, and the cash flow metrics need to be met at the higher debt level. Happy to look at any situations anyone is looking at advise what is possible. You can reach me here or directly at redacted

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