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Conversations with business leaders and changemakers on how they built their business and what keeps them going.
Pankaj (00:03)
Welcome to Letters of Intent, the podcast for deal makers and risk takers. I'm Pankaj Raval.
Sahil (00:07)
And I'm Sahil Chaudry and today we follow the money that isn't yours.
Pankaj (00:12)
Because somebody always puts money down. The only question is who and what they get for it.
So Sahil, no money down feels like a two AM infomercial topic. What are we doing this week talking about no money down?
Sahil (00:24)
Well, it's because the biggest backstop for Main Street acquisitions just rewrote its rules and they kick in eight days from now. I'm talking about the SBA.
Pankaj (00:32)
The SBA. Okay.
Sahil (00:34)
That's right. On August 14th, the SBA published a new edition of its lending rule book, SOP 50 10 8.1.
Pankaj (00:42)
Rolls right off the tongue.
Sahil (00:43)
That's right. It takes effect October 1st, and the trigger isn't your closing date. It's the date your loan gets an SBA loan number.
Pankaj (00:51)
So if you're mid deal right now, what does that mean?
Sahil (00:52)
Ask your lender
in writing which rule book your file is under. Homework item number one. Quick context. Okay, so in fiscal year 2025, the SBA guaranteed about 77,600 7(a) loans, roughly $37 billion, which is a record.
Pankaj (01:09)
And plenty of that was people buying businesses, right?
Sahil (01:12)
That's right. And until mid-2025, there was no mandatory minimum down payment on an SBA acquisition. Lenders could set their own bar. Some set it low, some even set it at zero.
Pankaj (01:23)
That was a really that was really a no money down era.
Sahil (01:26)
It really was. Then things changed. On June 1st, 2025, the SBA brought back a hard floor. Ten percent of total project costs on a change of ownership.
Pankaj (01:36)
So, you're saying total project costs, not the purchase price?
Sahil (01:38)
Correct, the price, the closing costs, any working capital in the loan, all of it.
The old rulebook's approach to equity had a nickname in the industry. Do what you do.
Pankaj (01:48)
Meaning
Sahil (01:48)
Meaning, lender, whatever your normal policy is for a non-SBA loan, do that.
Pankaj (01:53)
Great policy for a lender, but I guess terrible policy for a buyer who assumed the lender's rules were there to protect them.
Sahil (01:58)
That's right. And now 8.1 locks it down for a first-time buyer. The SBA calls it an initial acquisition. That ten percent can't be reduced or waived.
Pankaj (02:08)
So let's do the math on a million dollar deal.
Sahil (02:11)
So $100,000 of equity minimum, the seller can carry up to half of that. $50,000, but only on full standby.
Pankaj (02:18)
Define full standby.
Sahil (02:19)
Zero payments, no principal, no interest for the entire life of the SBA loan.
Pankaj (02:24)
Wait, wait, wait. say that again?
Sahil (02:26)
So, if the seller's note counts towards your down payment, the seller gets paid nothing on that note until the bank is paid off.
Pankaj (02:33)
So on a ten year loan that means a seller's waiting a decade?
Sahil (02:36)
And the other fifty thousand dollars has to come from what the SBA calls unlimited sources. Your own cash or a personal loan you repay from income outside the business.
Pankaj (02:46)
What about the classic move? Bring in a few small passive investors to cover the down payment.
Sahil (02:50)
That's what's new. Under 8.1 small passive investors land in the same capped bucket as the seller note. Together, they max out at half.
Pankaj (02:59)
So the investors and the seller are fighting over the same fifty thousand?
Sahil (03:03)
And if that investor money counts towards the injection, they can't take distributions beyond their tax bill until the loan is paid off.
Pankaj (03:11)
Wow. So invest with me, I'll cover your taxes.
Sahil (03:14)
Right. And there's two more. First-time buyers have to show 1.25 times debt service coverage on historical numbers, not projections. And once the business price hits $3 million, the lender has to order a quality of earnings report.
Pankaj (03:29)
Wow. And this is ordered by the lender, not the buyer.
Sahil (03:31)
Exactly. You can't hand them yours.
Pankaj (03:33)
Wow. So the first time buyers, the federal government just answered the no money down question. The answer is bring money.
Sahil (03:39)
The answer is bring money or bring a structure, which is the rest of this episode. So Pankaj, let's be fair to the no money down crowd. People really do buy businesses without writing a check. I've watched it happen.
Pankaj (03:49)
So have I, and every single time somebody wrote a check, it just wasn't the buyer.
And here's the principle the seller needs to get paid, and that money doesn't come out of your pocket. It comes from one of four places.
Sahil (04:00)
Okay, let's go.
Pankaj (04:01)
So first the seller lends you the price, a seller note. Second, the seller takes stock in your company instead of cash. Third, the business pays for itself. You borrow against the assets or sell off its future revenue.
And fourth, a lender with a government guarantee behind it.
Sahil (04:17)
And we just learned door number four now wants your cash.
Pankaj (04:19)
Right. So stop asking, can I do this with no money down? Ask whose money is it and what do they get for it?
Sahil (04:26)
Exactly, because nobody hands you money for nothing.
Pankaj (04:29)
Nobody. And the seller who carries a note gets a promise. The seller who takes stock gets a piece of the company. The lender gets a lien, and each of these is a legal right that can be enforced against you or lost by them.
Sahil (04:41)
And who's usually holding the weakest paper?
Pankaj (04:43)
So that's the part the infomercial skips of. In most of these structures, the person carrying the most risk is the seller. Often someone who's run a place for twenty years and wants to retire.
Sahil (04:52)
So I'll put nothing down really means
Pankaj (04:54)
Really means you, the retiree, will be my bank, my investor, and my collateral.
Sahil (05:00)
That's a lot of jobs for one person.
Pankaj (05:02)
And all unpaid.
Sahil (05:03)
That's right. So, okay, one cleanup while we're here, because people get this wrong online. SBA 504 loans aren't just real estate. They finance major fixed assets. Buildings and land, yes, but also long-term machinery and equipment.
Pankaj (05:17)
Noted and the acquisition rules we just walked through. right.
Sahil (05:20)
Well, those are 7(a). That's
the program built to finance changes of ownership. Here's the map for the rest of the show. Three doors that don't need the government, the seller as your bank, the seller as your investor, and the business paying for itself. Each one works, each one has a string.
Pankaj (05:36)
So door one, the seller carries paper. Sahil, why would any seller agree to be the bank?
Sahil (05:41)
Three reasons, a higher price, interest income, and taxes.
Pankaj (05:44)
The installment method.
Sahil (05:45)
That's right. Under section 453 of the tax code, if you sell property and at least one payment lands after the year of the sale, you generally report the gain as the payments come in, not all up front.
Pankaj (05:57)
So the seller's tax bill follows the seller's cash.
Sahil (06:00)
Mostly.
Here's where sellers get burned. Depreciation recapture. The slice of the gain that's ordinary income because you took depreciation over the years, gets reported in the year of the sale, no matter when you get paid.
Pankaj (06:12)
Say that again.
Sahil (06:13)
So a seller who finances the deal can owe tax this year on money they won't collect for many years to come.
Pankaj (06:20)
Mm, interesting. And inventory?
Sahil (06:22)
Doesn't get installment treatment at all. So in an asset sale, the purchase price allocation isn't paperwork. It decides how much of the seller's tax comes due right away.
Pankaj (06:31)
Interesting. Which makes a negotiation point for the buyer, too.
Sahil (06:34)
The best one you have. If you're asking a seller to finance you, show up already knowing their tax picture. It's the most generous thing you can do and it's real leverage.
Pankaj (06:43)
Interesting. So how you structure the bill of sale and how the purchase price is allocated is extremely important and people need to generally have CPAs involved as well at this point.
Sahil (06:53)
Definitely. You need to consult with your CPA because you don't want to pay or you wanna avoid to the maximum degree possible paying money that you don't have yet.
Pankaj (07:02)
Absolutely. So now let's lay it on the bank, Sahil.
Sahil (07:03)
If there's senior debt, the bank wants the seller notes subordinated, behind them in line. And if that note is counting toward an SBA down payment, it's full standby. Zero payments for the life of the loan.
Pankaj (07:15)
So in practice you might see two seller notes.
Sahil (07:18)
That's become common. One on full standby that counts as equity. A second one subordinated paid on terms the lender signs off on.
Pankaj (07:26)
So if I'm the seller, what do I ask for?
Sahil (07:28)
Security interest in the business assets, even if it's second in line, a personal guarantee from the buyer, real financial reporting, monthly or quarterly, and default triggers, including a default on the bank loan.
Pankaj (07:40)
Because the bank default is your early warning.
Sahil (07:42)
That is the smoke alarm. You want it wired to your house, not just theirs.
So an earnout is basically a seller note with a mood ring. The seller gets paid only if the business hits targets after closing, which means the buyer's decisions, pricing, hiring, even accounting choices decide whether the seller gets paid.
Pankaj (08:00)
So the definitions matter more than the dollar amount.
Sahil (08:02)
Every time. Define the metric, the accounting rules, and what the buyer is not allowed to do to tank it.
Pankaj (08:08)
So seller financing isn't a trick. It's a loan from one person who knows the business best. Document it like a loan, protect it like a loan, and it's one of the most honest tools in deal making.
Sahil (08:17)
Alright, here we go. Door number two. Sell me your business and instead of cash, I'll give you stock in the bigger thing we're building. Pankaj, does that actually work?
Pankaj (08:25)
Well, with the right seller, yes. Somebody who loves the work and hates the back office, the contractor who never wants to run payroll again.
Sahil (08:33)
The roll up pitch.
Pankaj (08:34)
We'll handle the admin, you keep running crews, you get a salary and a slice of something bigger. The honest version is that the pitch is generally attractive to some people.
Sahil (08:41)
But
Pankaj (08:42)
But look at what the seller has traded. A business they controlled 100% for a minority stake in the company they don't control, run by people they met six months ago.
Sahil (08:51)
Plus a job.
Pankaj (08:51)
Plus a job. Now, they're an employee. These are some people who have never been employees for 20 years, right? And all of a sudden they're an employee and the company they started, it's not always an easy psychological transition. And worst of all, that job in that new company could end.
And on top of there's a securities element here because buyers miss that constantly. When you pay someone in stock, you are selling them a security.
Sahil (09:10)
Even though they're the one handing you a business.
Pankaj (09:12)
Even then, every offer and sale of securities has to be registered or exempt. Most private deals lean on 506(b) or Regulation D.
Sahil (09:20)
Which is easy if the seller is accredited.
Pankaj (09:22)
Right, for an individual that's a net worth of a million dollars, not counting their home or income over two hundred thousand a year or three hundred thousand with a spousal partner for each of the last two years.
Sahil (09:30)
Plenty of sellers clear that because the business itself counts towards net worth. Sell a small shop and maybe not.
Pankaj (09:36)
And if they're not accredited, 506(b) generally allows it, but you still owe them real disclosure. Generally the same kind that you would provide in a registered offering, including financial statements.
It's exactly the problem. So let's talk about the second point here. Taxes. Seller hears stock, not cash, and assume there's no tax.
Sahil (09:53)
It's not automatic.
Pankaj (09:54)
It's not automatic. It's very important they recognize this. Swapping your business for stock is a taxable exchange unless it fits in the non-recognition rule. For a new holding company, the usual one is a Section 351. And it only works if the people contributing property own at least 80% of the corporation right after.
Sahil (10:11)
Okay, let's say that again because this is the one that hurts.
Pankaj (10:14)
So if the structure misses, the seller can owe real tax on stock they didn't sell.
Sahil (10:18)
Real tax but paper asset.
Pankaj (10:21)
There are other paths, reorganization under Section 368, or an LLC taxed as a partnership, but someone has to design it on purpose, before the LOI, not after.
Sahil (10:32)
And one SBA footnote.
Pankaj (10:34)
Go.
Sahil (10:34)
Under the new rulebook, a first-time buyer's SBA deal generally requires the seller to exit completely. Keeping the seller on as an owner is its own category with its own tests.
Pankaj (10:44)
So the seller keeps a big piece and I buy them out over time is a different deal.
Sahil (10:48)
Different deal, different rules.
Pankaj, if you're the seller taking stock, you're now a minority investor. And so you should negotiate like one. You need information rights, tag-along rights if the company gets sold, a realistic path to liquidity, dividends or distributions, and you need an employment agreement that spells out exactly what cause means because there are different repercussions for being terminated for cause or without cause.
And so you need to spell all those out as though you're negotiating as a minority investor.
Pankaj (11:16)
Absolutely, absolutely. Really important. Really important to have good counsel on your side doing all this. So Sahil, let's look at door three now. This one's the cleverest. A business pays for its own sale. Walk me through it.
Sahil (11:26)
Two versions. Version one, the business owns equipment, receivables, maybe real estate, and nothing's borrowed against them. So at closing you borrow against the company's own assets and hand that cash to the seller.
Pankaj (11:38)
That's a leveraged buyout.
Sahil (11:39)
That's right, the LBO, that's a leveraged buyout. Smaller check, fewer suits.
Pankaj (11:44)
And the legal risk?
Sahil (11:45)
Fraudulent transfer, which is a terrible name because nobody has to commit fraud.
Pankaj (11:49)
Explain.
Sahil (11:50)
Look at it from the company's point of view. The company pledged its assets. The cash went to the seller. What did the company get? That's
Pankaj (11:56)
New owner.
Sahil (11:57)
it. So if the company later fails, say it was left with too little capital to survive, a bankruptcy trustee can try to unwind the deal under the bankruptcy code that reaches back two years using state law, usually four.
Pankaj (12:10)
So unwind it against whom?
Sahil (12:11)
The seller who got the cash, the lender whose lien can get knocked out, potentially the new owners.
Pankaj (12:17)
So the seller who retired to Arizona?
Sahil (12:20)
Can get a letter asking for the money back.
Pankaj (12:22)
So that's the human cost. That seller did nothing wrong except accept a check from a structure nobody stress-tested.
Sahil (12:28)
Which is why the fix is boring. Model the company's cash flow after the new debt. If the business can't breathe with that loan on it, the structure is the problem.
Pankaj (12:36)
So why do lawyers call it constructive fraud?
Sahil (12:38)
Because the law constructs it. No bad intent required. If the company didn't get reasonably equivalent value and was left insolvent or undercapitalized, that can be enough.
Pankaj (12:48)
So math, not motive.
Sahil (12:49)
Math, not motive.
Pankaj (12:50)
Right. So okay. So let's try version two here.
Sahil (12:54)
Version two, version two is revenue, no hard assets, but steady card sales. A funder advances cash against the company's future receipts, a merchant cash advance.
Pankaj (13:03)
And the contract says it isn't a loan. It's a purchase of future revenue. So usury laws don't apply.
Sahil (13:08)
Well, that's what the contract says, but courts look at what the deal actually does.
New York courts, and a lot of these contracts pick New York law, ask three questions. Is there a real reconciliation? So payments actually move with revenue? Is the term truly open-ended? And does the funder lose if the business fails?
Pankaj (13:25)
And if the honest answers are no.
Sahil (13:26)
Then it can be treated as a loan. And in New York, when the effective rate runs past the 25% criminal usury cap, courts have voided these agreements. One recent bankruptcy decision found an effective rate over 100% and declared the deal void from the start.
Pankaj (13:40)
And the regulators?
Sahil (13:41)
In January 2025, the New York Attorney General announced judgment and settlement of more than $1 billion against a group of cash advance providers. Over $534 million in small business debt canceled.
Pankaj (13:53)
Wow. The alleged rates?
Sahil (13:54)
Up to eight hundred twenty percent a year, the companies didn't admit or deny the allegations.
Pankaj (13:59)
So the lesson for a buyer isn't every cash advance is illegal.
Sahil (14:01)
No, it's that daily debits built for a 60 day payoff are the wrong tool to pay for a business you plan to own for 10 years.
Pankaj (14:08)
So when the business pays for its own sale, the business carries all the risk. And when the business carries more risk than it can hold, we're saying that the law has ways of handing that risk back to whoever took the cash.
Sahil (14:20)
That's exactly right. So, Pankaj someone is watching this and has a target in mind. What do they do on Monday?
Pankaj (14:27)
Run a five question stress test before you send an LOI. One, list every dollar the seller receives at closing and where it comes from. Every, every dollar.
Sahil (14:35)
If the answer is vibes, stop.
Pankaj (14:39)
And for each source, what do they get? A lien, a guarantee, stock, standby note? Write it all down.
Third, can the business carry the debt on last year's actual numbers? The SBA's new benchmark for first-time buyers is 1.25 times the coverage. Borrow the yardstick even if you never touch the SBA loan. And fourth, if the business stumbles in year two, who gets hurt? And can anyone come after the seller's cash? And then lastly,
What's the seller's tax result? And are you issuing them securities?
Sahil (15:07)
Scoring?
Pankaj (15:08)
Clear answers on all five. You have a deal. Three or four, you have a draft. Fewer than three, you have an idea.
Sahil (15:14)
And the course that promises all of this with none of your money and no experience.
Pankaj (15:18)
The FTC's own consumer guidance is blunt. If a program promises guaranteed income, big returns, and a proven system, treat that as a red flag.
Sahil (15:26)
No money down is a financing structure, not a strategy. Price the strings before you pull them.
Pankaj (15:31)
So in closing, somebody always puts money down. The only question is who and what they get for it. Thank you all for joining us on this episode of Letters of Intent, the podcast for deal makers and risk takers. If you're buying a business, selling a business, or thinking about exiting a business, please let us know or contact a lawyer who can help you with this because as we discussed today, there's a lot of
issues, red flags to look out for when buying or selling a business and you want to make sure you don't make a false move that could cost you tens of thousands or hundreds of thousands of dollars in the end.