One thing I always try to stress to small business owners is to watch out for the Shark Tank myth.
It's easy for entrepreneurs and small business owners to glamorize equity based on TV shows and the Silicon Valley persona, but there are some serious drawbacks to it as well. You have essentially married your new business partner, and if things go south, you could be in for a contentious divorce. The decisions are no longer solely yours, and neither are the profits.
I always urge small business owners to consider other financing options before making the decision to bring in an equity partner. For example, when taking out a loan, you know exactly how much interest you are going to owe the bank and when your relationship will end. With equity, on the other hand, there is no limit to the number of profits that will go to your new partner and no end date in sight.
Inevitably, people's interests and needs will change over time and business partners grow apart. Luckily, I am able to help those entrepreneurs buy out their partners utilizing the SBA 7 (a) program.
Let's say you own 60 percent of your business, and you have a partner who would like to leave who owns 40 percent. To figure out what the company is worth, you must order an appraisal from an SBA-approved appraiser. This can sometimes cause conflict because what you think your business is worth and what the appraiser thinks your company is worth can be two different things.
In addition, the SBA will only lend the partner's percentage of the appraised value. Therefore, if your partner wants more, the SBA will not cover it. If a business is worth $1 million, the bank would likely lend you $400,000 to buy out your partner's share. The loan terms would be ten years, giving you time to pay it down, at 6 percent interest. While this interest rate is slightly higher than what you would get with a conventional loan, you'll have lower monthly payments ($4,441) that won't put too much strain on your current cash flow.
There is also 100 percent financing available (no down payment) if both of the following conditions are met:
- Purchaser has been in the business for at least 2 years at the same, or more, percentage of ownership
- Prior to purchase, the company is not leveraged more than 9 times on the last interim and fiscal year-end balance sheet
I fully understand that debt is not for everyone, but it can be a great tool if you have a plan and use it correctly. My last tip is to invest in an appraisal early on. The objective number on that piece of paper will pretty quickly tell you if there's a chance of this moving forward or not.