How does financing work when you buy a business with partners or outside investors?

The ownership table is part of the credit

When one person buys a business, the lender asks whether that person can run it and whether the business can carry the debt. When a group buys, there are more questions. Who owns what at closing? Who runs the business day to day, and who is only writing a check? Whose money is equity and whose is a loan? Who signs the guarantee? And does anyone in the group affect whether the business qualifies for the loan at all?

The common shapes are two or three operating partners splitting the work; one operator backed by friends, family or angel investors who stay out of the business; and a searcher or independent sponsor backed by an investor group, where the operator's stake is partly earned rather than paid for. The last two are covered in search fund acquisition financing and independent sponsor debt financing. The lender's questions are the same in each; the answers differ.

Who has to guarantee

On an SBA loan the rule is fixed: every owner of 20% or more personally guarantees the loan, without limit. Lenders may also ask for guarantees from owners below 20% or from key managers when they judge it necessary. The rule is explained in the SBA 20% owner guarantee.

Two points matter more than the threshold. First, SBA guarantees are typically joint and several: each guarantor can be pursued for the entire unpaid balance, not a share matching their stake. Second, setting stakes just under 20% to keep investors off the guarantee is visible to lenders and draws exactly the scrutiny it is meant to avoid. If an investor will not guarantee, the honest structure is a smaller stake or a conventional loan where the lender agrees to that, not an ownership table drawn around the line.

Conventional lenders are not bound by SBA's rule. Banks lending to owner-operated companies usually want the operating owners and any large owners to guarantee, and may accept a limited or several guarantee from a passive investor, capped at a set amount or at their share. Private credit funds lending to deals with an institutional sponsor often ask for no personal guarantee at all, and price and structure the loan accordingly. The trade-offs are in limited versus unlimited personal guarantees and the personal guarantee on an acquisition loan.

Investor equity, investor loans and preferred terms

Investors can put money in several ways, and the lender treats each differently. The label on the document matters less than whether the business, or the buyer, has to pay it back.

Investors are often promised a preferred return or regular distributions. Those payments come after debt service, and loan agreements limit them through restricted payments covenants, explained in restricted payments. SBA loan proceeds cannot fund a distribution to owners at all. Promising investors a fixed yearly payment before seeing what the lender will allow is how groups end up renegotiating with their own investors after the term sheet arrives.

Equity from investors does more than satisfy an injection rule. Every dollar of genuine equity reduces the loan, and a lender reading a deal where the operator and the investors both have real money at risk reads it as better aligned than one financed almost entirely with debt. How much equity lenders want is in how much equity you need to buy a business.

Operating partners and silent partners

Lenders want to know who is in charge. A group with one partner running the business and relevant experience to show for it reads well. Two or three equal operating partners with no stated division of roles reads less well, because the lender cannot tell who decides when they disagree. SBA lenders will want each owner's background and a résumé for the operator, and weigh industry experience the way it is described in buyer industry experience requirements.

Every operating partner also has to be paid, and lenders count that pay before debt service. A worked example in plain numbers. A business earns 1,000 a year before any owner pay. With one operator drawing 150, earnings available for debt service are 850, and at a minimum coverage of 1.25x the business can carry debt payments of up to 680 a year. With two partners each drawing 150, earnings available fall to 700 and the payments the business can carry fall to 560. A second full-time salary costs the deal 120 a year of debt capacity, which has to be made up with more equity or a lower price. Salary treatment is in the buyer's salary in acquisition DSCR.

Silent investors are underwritten differently: not on skill, but on character, credit and whether they bring any eligibility problem with them. Two come up often on SBA deals:

• Affiliation. An investor who controls other companies can make those companies affiliates of the borrower, and SBA counts affiliates together when it checks whether a business is small enough to qualify. A well-meaning investor with a larger operating company can put a deal over the size standard. See SBA affiliation rules.
• Citizenship and residency. SBA's current rules restrict ownership by people who are not U.S. citizens, and those rules have changed more than once recently. Check any investor who is not a citizen with the lender, against the rules in force at the time, before offering a stake.

Where the seller wants to keep a piece of the business as one of the partners, the SBA rules change: in a complete change of ownership the seller may not stay on as an owner, officer or employee, and a seller who stays as an owner makes it a partial change of ownership with different rules. See rollover equity in acquisition financing.

Setting the table before investors are promised terms

Most of the problems on group deals come from promises made to investors before anyone asked a lender. The decisions to make first:

• Who owns what at closing, and therefore who guarantees. Tell every prospective 20% owner that on an SBA loan they will sign an unlimited personal guarantee.
• How each investor's money goes in. Equity, a loan, or preferred terms, and what each does to the injection and to debt service.
• What investors are paid, and when. Distributions come after debt service and within the loan's covenants.
• Who controls the company, and what happens on a deadlock, a partner's death or disability, or a partner who wants out. Lenders commonly ask for life insurance on the key operator, and a buy-sell agreement they can read.
• Which company borrows. A holding company owned by the investors, or the operating company itself. See holding company structures for acquisitions.

The ownership table decides guarantee exposure and eligibility. Draw it with the lender's rules in hand, then take it to investors.

The documents follow the ownership. On an SBA loan, each owner of 20% or more provides personal tax returns for two to three years and a personal financial statement, and the lender will want the operating agreement or shareholders' agreement, subscription documents showing where investor money came from, and the operator's résumé, alongside the business's figures, the target's latest full year and the letter of intent.

Transparent's package sets out the ownership, the guarantors and the sources and uses in one place, so lenders read the group as it will stand at closing. Where investors will not guarantee, the book's 1,148 lenders writing term and private credit include lenders that structure without personal guarantees, at a price, alongside 278 that write SBA 7(a) and 504. How Transparent reads a deal is in how we underwrite.