SBA Loans and Earnouts

investor profile

March 30, 2020

by an investor from University of California, Berkeley - Haas School of Business in San Francisco Bay Area, CA, USA

Does anyone know if SBA loans can support an earnout?

We are looking to buy a $1.5M EBITDA business for $6M. The business is experiencing some weakness due to COVID and we have agreed on an earnout structure to de-risk the deal. We would pay 60% upfront and the remaining 40% when the business returns to pre-COVID gross margins on an LTM basis. We are trying to understand if this structure can work with an SBA loan. For example, could 40% of the loan be drawn at a later time (but approved now) or could 40% of the loan proceeds be deposited in an escrow account until it is paid?

Appreciate any insights from the SBA experts on this forum.

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commentor profile
Reply by a lender
from University of Missouri in St. Louis, MO, USA
Seller notes can be contingent on performance as long as you are not trying to give them more money than the original purchase price. Russell's idea of an escrow is a cleaner way to do this. However, in both cases the issue you are likely to run into is that the business evaluation has to support the full purchase amount, inclusive of the seller note if you go that route. If you are having an issue there then your options are limited. If the business is asset light, you might consider asking for seller financing. 10 year term with a 28+/- month balloon. You can refinance a seller note with an SBA loan after 24 payments have been made if the company is doing well (i.e. cash flow supports the loan). If there are assets in the business you could try and use those for the debt (non-SBA) and have the seller take back the remainder in an earn out.
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Reply by a lender
from Butler University in Columbus, OH, USA
Seller earnouts are prohibited. Buyer rebates based on business performance are allowed. Buyer rebates based on business performance are permitted because this is a benefit to the Borrower. If Borrower receives funds: a. Should first be applied to pay down the loan to a point that will not trigger a subsidy recoupment fee b. Any remaining funds may be used for business purpose In addition, Seller notes may be written to have some or all of the debt forgiven/reduced based on performance.
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