12 May Selling Your Business to a Family Member? Here’s What SBA Financing Changes
Family-owned businesses continue to play an outsized role in the New Mexico economy, where most businesses are small and owner-operated. Yet despite how common these businesses are, succession planning remains one of the least addressed challenges facing owners approaching retirement or transition.
Many owners assume that selling to a child or other relative will be simpler than selling to an outside buyer. In reality, family transitions often introduce a different set of operational, financial, and emotional complexities. Particularly, when the SBA is involved.
Keeping ownership within the family can help preserve relationships, maintain company culture, and create continuity for employees. At the same time, these transactions frequently require compromises that would not arise in an arm’s-length sale. Sellers may accept a lower purchase price, remain involved longer than anticipated during the transition process, or take on additional financial risk in order to help complete the transfer.
One area where these transactions have become increasingly complex is SBA financing.
Because these deals occur between related parties, lenders often scrutinize these transaction even more closely to ensure they reflects a legitimate change of ownership, adequate buyer capitalization, and a true transfer of operational control.
What is the SBA Protecting Against?
First, it’s important to understand what the SBA 7a program is for and why its rules are in place. The government wants to ensure that its funds reflect a fair market valuation, aren’t implicated in any fraud, and are being used to support a buyer’s total control over the business they are purchasing.
It’s not designed to fund cash-out refinances, insider deals where the price is artificially inflated or deflated for non-business reasons, or as a way to get around gift and estate planning regulations. The business truly has to be transferring hands from one party to another, and that means that the family member purchasing the business cannot be a shareholder or member in the existing corporation or limited liability company. Likewise, the seller cannot have any formal ties to the purchasing entity. In short, it has to be a true arm’s-length transaction, even between family members.
When a Lower Price Becomes a Gift of Equity
As alluded to above, the purchase price must still be supported by a third-party business valuation, even when both parties agree to a lower number. If the agreed purchase price falls materially below the appraised value, lenders may treat part of the transaction as a gift of equity rather than a conventional sale.
While this lower price can help the deal get done, in most instances the bank is required to have the seller provide a gift letter stating that they don’t expect this money to be repaid. More importantly, it may have tax and estate planning consequences for both parties. The SBA does not want this to become a transfer of wealth by other means, and therefore below market pricing. The transaction may involve filling out the relevant IRS forms, evaluating how the transfer applies to the parent’s lifetime estate and gift tax allocation, and other estate planning considerations, particularly if multiple heirs are involved and one seems to be getting favorable treatment.
It can quickly become complicated, and that’s why it’s best to discuss with your CPA and estate planning advisor beforehand. The simplest path is pricing the business at or near the appraised value.
Contributing to the Down Payment
Buyer equity injection – more commonly referred to as the down payment – also receives additional scrutiny in family transactions. If parents or relatives are contributing funds toward the down payment, lenders will typically require formal gift letters and documentation showing the funds are not expected to be repaid.
If the owner does expect their contribution to be repaid, lenders may require the note to remain on full standby for the life of the loan. In practical terms, that may mean the Seller cannot receive principal or interest payments during the term of the SBA loan, which is typically a minimum of 10 years.
A Definite End Date for Seller Involvement
Another surprise for many owners is that family succession does not allow for a gradual or indefinite transition out of the business. SBA lenders expect the seller to fully step away from day-to-day operations – and even any formal consulting arrangements – by one year after closing. This is not a soft guideline, but an SBA policy, and exceptions are rare. That can create tension in family transactions where the expectation may be a slower or more informal handoff.
If you’re selling to a family member who has already been working in the business and is ready to take the reins, the scrutiny is likely to be far less than to a child who has little direct exposure to day-to-day operations.
Final Thoughts
None of this means family succession is a bad strategy. In many cases, it remains the best available option to preserve your business legacy, protect employees, and transfer the business to a family member who is the best fit to run the business. SBA financing is a path to get there but just be aware of the additional steps and considerations it will involve. It can end up being more structurally complex than some sellers realized.
Sam Goldenberg & Associates helps business owners navigate the financing, valuation, and transition issues that often arise in family business sales.
