Demystify SBA policy about earn-outs?

June 24, 2022

by a professional from University of Southern California - Marshall School of Business in North Palm Beach, FL, USA

Does anybody know/want to speculate on why the SBA won’t guarantee business acquisition financing if an earn-out is part of the transaction?

Possibilities: (?)

Something must be wrong with the business for the owner/seller to accept conditional payments?

The business is overvalued, but the buyer wants to control the company and is conditionally willing to pay more to get it?

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

From my understanding there are several reasons behind it. Ron is correct on the first one, The SBA wants to underwrite to the final purchase price. Secondly, the SBA does not want a situation where a payment needs to be made in the future and there is no cash flow to make that earn-our payment, hence creating some sort of default / legal situation. Third, the SBA wants to ensure the business ownership actually transitioned. Often times with earn outs there is an expectation the seller will continue to stay involved for a longer period of time, and they want to be sure the business control actually transfers.

Personally for some reasons I think an earn-out would make sense if structured the right way, but I don't expect the SBA is going to change this rule any time soon, so I guess seller notes is going to continue to be the only way to offer buyer protection.

Reply by an intermediary
from Boise State University in 800 W Main St, Boise, ID 83702, USA

What Ron said. And earn outs can be troublesome for sellers because the seller has no control over the company performance because SBA Financing requires a 100% transfer of ownership. After the sale, a seller can only remain employed for up to 12 months as a 1099 contractor (i.e. no management control),. So, logically, it makes sense that neither a seller, nor the SBA lender would want to be in that uncertain position regarding the ultimate sales price.

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