🚨 Breaking: The SBA Just Redefined “Search Funds” And Got It Wrong
A critical update that could derail legitimate acquisitions and what you need to do about it.
Let’s be clear upfront:
The SBA’s newly issued guidance takes aim at search fund deal structures. But while it claims to address “emerging practices,” what it actually does is mischaracterize the way most search funds work and in the process, threatens to invalidate well-structured, compliant transactions.
If you're an entrepreneur raising funds to acquire a business, or advising someone who is, this rule change affects you. In fact, it may determine whether your deal gets financed at all.
📜 What Changed: SBA’s New Rule on Search Funds
The update comes through SBA’s Standard Operating Procedure (SOP) 50 10 7.1, which governs eligibility for 7(a) loans — the primary debt instrument used by acquisition entrepreneurs.
Here is the text of the new rule:
It contains two key changes relevant to search funds:
1. Control Provisions for Non-Guarantor Investors
“Businesses that have entered into an agreement for control (including a side agreement) that gives a non-guarantor owner/investor control of the business are ineligible.”
(Section A, Chapter 1, Paragraph E.3, Page 20)
In other words, if any investor who is not personally guaranteeing the loan is deemed to have control of the business, via side agreement or otherwise, the loan is disqualified.
2. Equity Repayment Characterized as Debt
“An equity investment is not subject to an agreement to repay equity or make distributions to recover an investor’s investment prior to release of the guarantee.”
(Section B, Chapter 2, Paragraph V, Page 128)
If your deal includes equity that must be repaid, or includes mandatory distributions, before the SBA guarantee is released, the SBA will treat it as debt, not equity.
And debt that’s not part of the approved loan package? Ineligible.
These two concepts… “control” by investors and “repayment” of equity… are now critical to eligibility.
🧠 How It Works in Practice: The Reality of Search Fund Structuring
Here’s what the SBA got wrong.
✔️ Yes, Search Funds Are Real
Search funds are legitimate, structured vehicles. An entrepreneur (the “searcher”) raises capital to fund the acquisition of a business they’ll actively operate. The capital may come from a small group of investors or be entirely self-funded.
That definition, which the SBA includes in its guidance, is factually accurate.
✔️ Yes, Investors Often Take <20%
This is a common and compliant practice. Investors take less than 20% equity precisely to avoid triggering the SBA’s personal guarantee requirement. The bank knows this. The borrower discloses it. There is no deception.
❌ No, Investors Don’t Have “Side Agreements” for Control
This is where the SBA’s logic collapses.
We do not recommend side agreements. Ever.
In fact, we explicitly advise against them. Why? Because any undisclosed governance arrangement tied to a federally-backed loan opens the door to SBA fraud, wire fraud, and serious criminal exposure.
All deal terms must be disclosed to the bank and included in the governing documents… the operating agreement, stockholders agreement, or otherwise.
If there’s a side letter giving an investor de facto control? That’s not a gray area, it’s a red flag. And it’s not common practice.
🧩 What the SBA Might Be Referring To: Minority Investor Protections
In most deals, especially those with professional investors, it’s common to include basic minority protections… i.e., provisions that allow investors to prevent fundamental harm to their investment. These might include:
A veto on amending governing documents
Restrictions on unilaterally issuing new equity
Approval rights on major asset sales or debt incurrence
Protection from dilution without consent
These are not control rights.
They are protections, and they do not override the fact that the entrepreneur remains the sole manager of the business.
In nearly all search fund deals, the searcher retains management authority and decision-making power. The investors are passengers, not pilots. In fact, they don’t want control!
Note that upmarket investors sometimes think search investors are crazy for this, but those are the facts, nonetheless.
💸 The Return-of-Investment Clause: A Misunderstood Threat
The SBA’s second assertion ‘that investors must not have any agreement to recover their equity before the guarantee is released’ is vague and potentially damaging.
Let’s unpack the possible meanings:
✅ If “require” means a put right or redemption (forced buyback by the company):
This is already discouraged by most counsel, including ours. These clauses pose liquidity risks. If an investor can force the business to buy out their equity in five years, that creates a future cash obligation that might not be manageable.
We routinely advise searchers to reject these provisions or convert them to optional redemptions or long-term promissory notes.
❌ But if “require” is interpreted broadly, as in any expectation of repayment, we’re in trouble.
Many deals include preferred equity with return mechanics:
Preferred returns
Tag-along rights on exit
If those are now seen as debt, not equity, then the deal is disqualified.
Period.
This interpretation would create a chilling effect, especially for capital providers who’ve operated well within the rules.
⚖️ Implications: Who This Hurts Most
This policy shift doesn’t stop abuse. It could (if wrongly interpreted) discourage legitimate deals.
Self-funded searchers may be unaffected.
But entrepreneurs raising outside capital now face uncertainty about what’s allowed.
Investors will demand safer structures or walk away.
Lenders may overcorrect and reject deals even loosely resembling a search fund.
The ambiguity is the danger. The SBA hasn’t drawn bright lines, they’ve sketched vague boundaries, and everyone is left guessing what will trigger disqualification.
🛡️ So What Should You Do?
If you're raising funds to acquire a business using SBA financing, this is not the time to get clever or take shortcuts.
✅ Keep it simple!!
✅ Disclose everything.
✅ Avoid any side agreements not included in your deal docs.
✅ Be extremely cautious with preferred equity or redemption features.
✅ Have a qualified attorney who actually understands this space structure your deal.
Because now more than ever, you need a great lawyer — one who can draft investor terms that protect you, comply with SBA guidance, and actually close.
If you're not sure whether your deal fits within the new rules, or how to clean up a draft that doesn’t, don’t guess.
🎓 Want More?
This week in the Business Buying Masterclass, I’ll be sharing deal templates, redline examples, and a full teardown of how to navigate investor protections under this rule.
If you're raising money, buying a business, or just want to understand how this space is evolving, now’s the time to level up.
Disclaimer:
This newsletter is for informational purposes only and does not constitute legal, financial, or tax advice. I am not your lawyer, and no attorney-client relationship is formed by reading this content. Always consult your own advisors before acting on anything you read.
Really excellent breakdown. There have been a lot of questions following the June 1st SBA rules update.