SBA 7(a) Update — Partial Changes of Ownership

U.S. Small Business Administration (SBA) offers a number of loan programs to support the financing of small businesses. For those interested in acquiring an existing business, the SBA’s 7(a) loan guaranty program is the agency’s flagship program. It derives its name from Section 7(a) of the Small Business Act of 1953 (P.L. 83-163, as amended), which authorizes the SBA to provide business loans and loan guaranties to American small businesses.

For a sense of scope, in FY2021 the SBA approved 51,856 7(a) loans totaling $36.5 billion. The average approved 7(a) loan amount was $704,581. Loans can be up to $5 million and require as little as 10% down by the buyer.

In the past, the SBA did not allow sellers to roll over equity into the acquired business. This meant that sellers of small businesses were unable to "roll equity" as part of the sale of their business if an SBA 7(a) loan was involved, meaning that they were unable to maintain an equity stake in their business and have the opportunity for a "second bite at the apple" in the case that their business is subsequently sold at a higher price than they sold it for.

The U.S. Small Business Administration (SBA) has announced an update to its 7(a) loan program that will allow sellers to roll over equity into the acquired business by allowing "partial changes in ownership" that were once forbidden. This change is designed to make it easier for buyers to acquire businesses, especially those that are owner-operated.

The seller equity rollover update to the SBA 7(a) loan program is a great opportunity for buyers and sellers. Buyers can now acquire businesses with less cash or financing, and sellers can exit their businesses while still retaining an ownership stake.

Additional Information:

• SBA update (page 6)

• SBA 7(a) overview

• SBA 7(a) Terms

• Congressional Research Service overview of SBA 7(a) loans

• Legal overview of rule change allowing partial changes in ownership

Working Capital’s Role in the Sale of a Business

By Keshav Narendra-Babu

Working capital is the operational liquidity of a business or the capital need in order to run the business, usually defined as current assets minus current liabilities. It is essential to maintaining business operations.

Buyers of a business want to make sure that there is enough working capital left in the company in order for a smooth transition and efficient operations post-acquisition. In order to ensure this, buyers analyze the amount of working capital used in the company’s past months and calculate a working capital peg. A working capital peg is a specific target for the working capital needed in a company at the closing of an acquisition.

In order for a sale to be made, both buyers and sellers have to agree on a specific peg amount, and after the acquisition is confirmed, an outside assessor analyzes the

final balance sheets in order to determine the amount of working capital that was kept in the business. If the seller kept more working capital than the peg target, the excess amount is paid by the buyer to the seller. If the seller kept less working capital than the peg target, the deficit is paid by the seller to the buyer.

Negotaitions around working capital can present some of the most contentious parts of a business sale. Disputes often arises in the last few stages of an acquisition, when final terms are being negotiated. It’s important for business owners to understand the implications of working capital throughout their selling process in order to better position themselves

to receive a fair price for their companies.

Given the interests of all parties regarding working capital, it is important to strive for accuracy in calculating the working capital peg. There are several factors to consider, including the seasonality of a business, as the timing of an acquisition plays a significant role in working capital discussions. A seller should be looking over past balance sheets in order to compute average working capital and prepare early for working capital pegs that will be captured in the LOI. In this way, the seller is better positioned to preserve as much value as possible while also servicing the buyer’s needs and concerns in a fair manner.

See also:

• Further reading from BDO, an international accounting firm

• The perspective of an investment bank

• Some thoughts from a small private equity firm

Sea Change

Chair Powell answers reporters' questions at the FOMC press conference on May 3, 2023. Federal Reserve Photo, Public Domain.

In his memo "Sea Change," Howard Marks argues that the investment world may be experiencing the third major sea change of the last 50 years. Reflecting on his long investment career, he cites the first sea change occurred in the early 1970s when the Bretton Woods system collapsed and the world moved to a floating exchange rate regime. The second sea change occurred in the early 1980s, when the Federal Reserve under Paul Volcker raised interest rates sharply to combat inflation.

Marks argues that the current sea change is being caused by a number of factors, including the spike in inflation, the war in Ukraine, and the Federal Reserve's response to these events. These factors have led to a reversal of the market conditions that prevailed after the Global Financial Crisis and for much of the last four decades.

In the past two decades, investors have enjoyed a period of low inflation, low interest rates, and strong economic growth. This has created an environment in which asset prices have risen sharply and borrowers have been able to access cheap and easy capital. However, Marks argues that this environment is coming to an end.

The Federal Reserve is raising interest rates in an effort to combat inflation. This is likely to lead to slower economic growth and higher borrowing costs for businesses and consumers. As a result, asset prices are likely to fall and borrowers will face more difficulty accessing capital.

Marks believes that this sea change will create opportunities for investors who are willing to take on risk. He argues that lenders and bargain hunters will be well-positioned to profit from the coming market volatility.

In the context of the small business world, these conclusions suggest that the steady and broad-based increase in business valuations is over. Going forward, this privilege will be reserved for those businesses with superior operations.

Further Reading

• Sea Change, by Howard Marks (December 13, 2022)