Small Business Buyers Can Now Run a Play Private Equity Perfected

It used to be that purchasing a business with a Small Business Administration 7(a) loan, which allows buyers to finance up to $5 million, required the purchase of 100% of the company.

While buyers were generally willing to meet this condition to gain access to an SBA-backed loan, it meant small business buyers were effectively shut out of using one tactic common in private equity transactions: offering the current owner and key team members ongoing equity in the enterprise. Without the ability to use equity as both part of the purchase price and an incentive for the existing leadership to stay on, buyers missed a valuable opportunity to maintain continuity, preserve institutional knowledge, and foster a smoother transition. In other words, they were stuck with deals that didn’t let them fully leverage the talents of the people who had already built the company into something worth acquiring.

Last year, the SBA took a small step by allowing sellers to keep up to 20% of the equity in the company after the sale—just enough skin in the game to encourage a smoother handover–without having to also personally guarantee the loan. The catch was that this arrangement only worked for equity deals as opposed to the preferred method of an asset deal. In an equity (or stock) deal, you buy the company itself—its shares—and take over everything it is involved in, both the good (like its contracts and brand) and the bad (like exposure to lawsuits or back taxes). In an asset deal, you only buy the parts of the business you want—like its equipment, customer lists, or brand name—and leave behind anything you’d rather not inherit.

Now, the SBA is going further. Buyers who want an SBA 7(a) loan can, as of a December 2024 rule change, structure acquisitions as asset deals and still let sellers roll over equity–up to 20%. This change lets buyers pick and choose what they’re buying, leave the baggage behind, and still keep the former owner involved as a resource or just use the equity as a way to sweeten the deal.

“The change was made to allow borrowers to get a loan for a partial change of ownership when the owners wish to form a new entity that will own the operating company,” says a spokesperson for the SBA. “This is often done for tax or liability protection purposes. Before the change, no new entity could be formed.”

In plain English, the new SBA rule opens up more options for buyers. They can use equity as part of the deal, borrow less, and keep the seller involved to help with the transition. It’s a strategy private equity firms have long used to keep founders and key employees engaged, and now small business buyers can use it too. Effectively, it has the potential to turn small business acquisitions into something that feels a bit more “grown-up” from a deal-structuring perspective.

But there’s more to it. Previously, even keeping the old owner in the fold had its limits.

The previous rules wouldn’t let the seller stick around beyond a 12-month transition period. They had to sell the company, collect their check, and walk away, whether they wanted to or not. Still, the advantages of the SBA 7(a) program were so appealing that buyers were often willing to accept those limitations just to secure the loan. Purchasing a small business with an SBA 7(a) loan is appealing because it relaxes typical lending hurdles. Often, a personal guarantee replaces collateral, letting buyers close deals without much upfront cash. Borrowers also get longer repayment terms—up to 25 years instead of the usual 10—making ownership more affordable. The restriction on the old owner sticking around will no longer apply since, for all intents and purposes, where they’ll be working post closing will be an entirely new business.

Broadly speaking, here’s how asset deals under the new rule works, according to Kevin Henderson, the cofounder of SMB Law Group, a law firm that has advised on more than $1 billion of small business mergers & acquisitions since opening up shop in 2022. The buyer sets up a new entity, acquires the assets of the old business, and then gives the seller a piece of that new entity as part of the payment. The seller gets to cash out a portion of their ownership right away, but they also hold onto an equity stake that can grow over time if the business does well. Because anyone holding 20% or more of a 7(a)-financed business must personally guarantee the loan, sellers typically keep their stake below that mark—often even lower, since it’s at the lender’s discretion on who must sign the guarantee. This stands in contrast to mid-market private equity transactions, where minority investors rarely face personal guarantees.

Prior to the most recent change, Henderson points out that buyers were “pigeonholed” into equity deals, which many found to be a frustrating limitation. “There are a lot of reasons why asset deals are heavily favored for these business purchases,” he says. Foremost among them being that it distances the buyer from the prior company’s liabilities, making it as easy as just saying “you’re suing the wrong company” if a claim should arise after the deal has closed.

Still, SMB Law Group saw a rise in equity-based transactions after the SBA’s initial rule change. Equity transactions went from just 10% of their advised deals to about 40%, indicating that, even though the arrangement wasn’t perfect, many buyers were eager to give it a try.

But these equity-based structures aren’t without risks, as Eric Pacifici, Henderson’s cofounder at SMB Law Group, makes clear with a cautionary tale.

Pacifici shares an example where a buyer of a healthcare company inherited regulatory trouble from the previous owner, putting a third of the company’s revenue at risk and exposing it to potential fines. The problem started before the sale but became the buyer’s to solve afterward. In an asset deal, that liability and the ensuing headache would have been left behind.

Of course, just because small business buyers can now structure a deal with rollover equity—just like the big private equity firms—doesn’t mean it’s always a good idea.

Henderson and Pacifici warn that keeping the old owner around might be a great idea if you already have a good working relationship, but what if you barely know them? What if you buy the business and it turns out their style and yours just don’t mesh? At the very least, they suggest having a mechanism in place to buy back the seller’s equity if the relationship sours. Without it, you could end up stuck with a partner you don’t like, or a founder that undermines your decisions. This can be more trouble than it’s worth. And if things get really messy, it can mean lawsuits, lost revenue, and major headaches.

“How I see these partial buyouts go wrong most often is because the seller is having a really hard time recognizing ‘hey, I’m no longer the guy in charge’ and that leads to a lot of internal conflict,” Henderson says.