Illustrative example: a licensed director buys his employer's firm with SBA 7(a) and a seller note

This page is an illustrative composite, not a real client deal. The director, the owner, the firm, and the loan terms were assembled from situations we see when employees buy the firms they work for. Every number is invented, rounded, and labeled; the SBA rules cited are real.

The buyer is a 41-year-old licensed funeral director who has worked at a family funeral home in a small New England town for nine years. The owner, 70, still meets families but has handed most daily work to him. Both want the same outcome: the director owns the firm, the owner retires, and the families notice nothing but continuity.

Why does an employee buyer change the financing?

He knows the business and the families, which lenders like, but he has little cash. That combination points to an SBA 7(a) loan, which can finance most of the project if the equity and coverage rules are met.

The SBA’s 7(a) program page covers the basics. The deal rules come from SOP 50 10 8.1, effective October 1, 2026; SBA’s information notice on its issuance explains which applications fall under it. This is a full change of ownership, which the SOP treats as an Initial Acquisition. The buyer, owning 100%, signs an unlimited personal guaranty.

The lender also verifies the seller’s financial statements against IRS tax transcripts. That is where many employee buyouts first stall: if the returns show less profit than the internal statements, the lender underwrites the returns. This owner’s accountant reconciled the two before the application, so the add-back schedule tied to filed numbers line by line.

What did the firm earn, and what could the lender count?

Seller’s discretionary earnings were $386,000 on $1,475,300 of revenue. The lender’s coverage test starts from a smaller figure: earnings after the new owner’s own salary and the cost of covering his old shifts.

The $85,000 salary is a judgment call. The Bureau of Labor Statistics reported a May 2025 median wage of $78,790 for funeral home managers. A lender wants the owner paid enough to live on, so that the loan is not quietly serviced from his household budget. The rules for naming him funeral director in charge at closing vary by state and belong on the closing checklist.

How did the SBA rules shape the first structure?

The letter of intent priced the business at $1,185,000 and the building at $565,000. Equity had to be 10% of total project cost, and the seller’s standby note could supply only half of it.

The first sources and uses:

1. Project cost: $1,185,000 + $565,000 + $70,000 working capital + $62,000 assumed closing costs (guaranty fee, appraisal, business valuation, Phase I, legal) = $1,882,000.
2. Equity: 10% × $1,882,000 = $188,200.
3. Seller note on full standby: at most half, $94,100. The SOP requires it to be subordinated and on “full standby (no payments of principal or interest for the term of the 7(a) loan).”
4. Buyer cash: $94,100.
5. 7(a) loan: $1,882,000 − $188,200 = $1,693,800.

The Phase I is not optional here. SOP 50 10 8.1 lists death care services among environmentally sensitive industries, so the environmental review must begin with a Phase I regardless of loan size; our guide to Phase I reports for funeral homes explains the scope. And because the price is under $3 million, no quality of earnings report was required.

What happened when the business valuation came in low?

The lender’s independent valuation, from a credentialed appraiser as the SOP requires, put the business at $1,110,000, which was $75,000 under the agreed price. The building appraised at the price.

Under the SOP, total debt supporting the purchase cannot exceed the business valuation, and any excess price “must be made up by equity.” The buyer did not have another $75,000. Coverage was also tight: at the original price, the loan at an assumed 9.75% over a blended 174-month term cost $218,627 a year, and $273,000 ÷ $218,627 = 1.249x, just under the 1.25x minimum.

The owner chose to cut the business price to $1,110,000 rather than lose his employee as buyer. Earnouts were not available as a bridge, because the SOP prohibits seller earnouts in SBA-financed changes of ownership.

Does the final deal clear 1.25x coverage?

Yes, at 1.31x. The lower price reduced the loan, and a larger real estate share lengthened the blended term.

The stress line matters because 7(a) rates are often variable. The SOP limits change-of-ownership proceeds to 10 years except for the real estate portion; blending is how a lender reflects both. Try your own inputs in the SBA loan and DSCR calculator, and see our SBA loan guide for funeral homes for the rules in full.

What does the seller actually receive?

About $1,062,600 in near-term cash after debt, fees, and estimated taxes, plus a $90,350 note he cannot collect for roughly 14.7 years. Tax rates here are assumptions: 35% ordinary, 20% capital gain, 25% unrecaptured section 1250 gain, and 5% state.

The allocation assumed $150,000 for equipment and vehicles with a $33,000 basis, $30,000 for inventory at cost, $565,000 for the real estate ($85,000 of land at cost and $480,000 of building with a $170,000 basis after $230,000 of depreciation), and $930,000 to goodwill. Tax was computed on the whole gain in the year of sale. IRS Publication 537 explains when installment reporting can defer tax on deferred payments such as this note, though depreciation recapture is still reported in the year of sale.

The note’s real worth is the sobering line. At an 8% discount rate, $90,350 received in 14.7 years is worth $90,350 ÷ 1.08^14.69 = about $29,200 today. Whether interest may accrue during standby is a point to settle with the lender in writing; this example assumes it does not. The SOP says seller debt can be refinanced only after it has been in place and current for 36 months, so an early payoff is possible but not something to count on.

The owner also signed a 12-month consulting agreement at $2,000 a month, within the SOP’s 24-month limit, to introduce the new owner to clergy, hospice staff, and preneed families.

What is the lesson for directors and sellers?

An employee buyout under SBA rules works when the seller treats the standby note as a gift of time, not money, and when the price survives an independent valuation. Here the owner accepted about 6.3% less on the business so the right buyer could close. A seller who needs every dollar at closing, or who cannot wait 14 years for part of the price, should know that before agreeing to an SBA buyer, not after the valuation arrives.

Directors weighing this path should read our profile of the licensed director buying a first firm and the comparison of SBA 7(a) vs. seller financing. The broader buyer roadmap is on our buying hub.