Structuring Minority Investor in SBA 7(a) Deal — Seeking Advice

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by a searcher from Vanderbilt University
in Nashville, TN, USA

1yr ago

Structuring Minority Investor in SBA 7(a) Deal — Seeking Advice

I'm acquiring a $640K home services business using an SBA 7(a) loan. I have a strategic minority investor - he owns a large real estate brokerage and will help drive leads post-close. He’d like 20–25% equity, but the business is small, so he’d only be investing ~$50K. The issue: at his desired equity level (20%+), the SBA would likely require a personal guarantee (PG) and possibly even collateralization of his primary residence, which he understandably wants to avoid. We’re currently modeling 15% equity with no PG, plus a potential interest-only loan from him of $50K–$100K to boost working capital. That part works. However, it doesn't get him the distribution upside he’s targeting long-term. I’ve considered structuring a convertible note, where his debt converts to equity after a few years but I’m fairly certain the SBA prohibits any ownership changes until the 7(a) loan is repaid (which could be 10 years out). Any creative ideas to: Give him more upside without tripping SBA ownership/guarantee rules? Increase his economic participation without immediate equity or PG? He owns several other LLC entities and his wife does as well - if this unlocks anything. Thanks in advance.

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reply by an intermediary 1yr ago
from The University of Chicago in Chicago, IL, USA

In addition to what you are thinking, I wonder if following is allowed. Consider giving an option to make up for the 5-10% of equity that he can exercise at waterfall or after loan is paid off.

reply by a searcher 1yr ago
from University of Tennessee in Nashville, TN, USA

^redacted‌ Get better investors with more reasonable expectations and offer them all the same deal. Too many investors are overly greedy when it comes to expected returns. The larger investor pool is more favorable. A 1.5x Equity Multiple for the down payment is sufficient. Offer a 8% Preferred Return, the Equity Multiple would be 15% ownership stake for the investor (10% x 1.5), and the investor(s) should receive at least/in excess of a 10.8% annual return if the DSCR is at 1.25 or above assuming you don't grow the EBITDA/SDE/Free Cash Flow. Beware of the multitudes of Searchfund investors that have VC-type returns in mind in exchange for their capital, especially those that aren't willing to risk what you will have to with a PG. You're buying yourself a job and a boss if you accept their terms. Remember why you're doing this and decide if you really want to exchange the Golden Handcuffs of corporate life for the Lead Handcuffs of those investors. There are better options available if you look for them.