One of my great joys is following the careers of industry professionals who have taken my training courses. We keep in touch now and then. I heard from Larry the other day. He took one of my training courses years ago and is now an exec of one of the larger CDCs. Once in a while he asks for my advice on deal structuring. He touched base the other day:
LARRY: Richard, you know that my CDC makes dozens of 504 loans every year. But now we have a customer looking to buy out his partner’s share of their business. We have never done a 504 for a partner buyout. I found the place in the SOP (50 10 5 (K) Subpart C IV K pg.322) and I understand it. But I’m clueless about structuring the financing. Can you help me out here?
ME: Great to hear from you! I’m very proud of your success since our training course. Partner buyouts can be touchy. Business partnerships end for many reasons, but we all agree that the end goal is a satisfactory solution for the departing partner, the one continuing with the business – and the lender. One of our goals at JRB is to increase the capacity of SBA lenders, big or small. Of course I’ll help you out. Tell me about the deal.
LARRY: Okay. The Buyout Agreement is for $12 million – $3 million for the “enterprise value” and $9 million for real estate. But it also says that the lien on the real estate for $7 million must be paid off so that the departing partner will no longer be liable.
ME: Ah, you remembered Lesson 1 of Day 1: Define Your Project. As you know, the purchase of blue-sky, goodwill, enterprise value, whatever you call it is not an eligible part of a buyout. The $3 million being paid for must be financed outside the buyout. Your eligible project is the real estate purchase: $9 million.
LARRY: Wait, I have to refi the $7 million. Don’t I have just a refi?
ME: Not at all. Let’s assume that you have a deal where the real estate is being sold by an unrelated person who owed $7 million against it. Sure, you would have to pay it off with a new loan. But that’s not a refi. Same with your project. It is the purchase of real estate for $9 million. No refi involved.
LARRY: So the project cost is $9 million, and he’s already got $3 million equity in the real estate. So the financing is $6 million. Thanks, man! I can take it from there. Have a nice day.
ME: No. Wait, wait, Larry. Not so fast! The buyer doesn’t have $3 million equity. The seller has half of that and we need to buy out his equity as well. He’s not giving it up for nothing. The buyer has only $1.5 million equity and so does the seller. You must pay the seller for his $1.5 million of equity.
LARRY: Now I’m confused.
ME: Lesson 2, Day 1. Now that you defined the project, you can structure the financing. You’re purchasing the real estate for $9 million. As you know, you cannot reimburse for equity. The buyer has $1.5 million of equity so that is his equity contribution.
LARRY: Hey, okay! I get the structure now. $9 million project cost. $1.5 million in equity. Our CDC can finance 40% of project for $3.6 million. The TPL does the rest for $3.9 million
ME: Yep. You got it. I knew you’d catch on. You were a great student. And you still are!
LARRY: Wow! Learn something new every day!
Let’s hear it for Continuing Education! At JRB, we’re all for it.
Senior Associate, CDC/504 Programs