The Shadow Side of SBA Deals: Side Agreements

Understanding Side Agreements: The Invisible Deal Within the Deal

Side agreements are supplementary contracts between buyers and sellers that exist alongside the main transaction documents but are deliberately not disclosed to lenders, the SBA, or other financing parties. These agreements modify the terms of the "official" transaction in ways that might not be approved if revealed.

Unlike amendments or addendums, which become part of the official record, side agreements are designed to remain private between the transacting parties. They create legally binding obligations that run parallel to, and sometimes directly contradict, the terms presented to financiers.

Common scenarios where side agreements emerge include:

• Circumventing lender requirements that parties find overly restrictive

• Creating financial arrangements beyond what's officially documented

• Extending seller involvement beyond permitted timeframes

• Creating unofficial earn-outs or contingent payments

• Reallocating purchase price toward assets that receive more favorable tax treatment

Example: The Personal Guarantee Workaround

The SBA's personal guarantee requirements represent one of the most common targets of side agreements. Standard SBA policy requires that anyone owning 20% or more of a business personally guarantee the loan, putting their personal assets at risk if the business fails.

Here's how some deals attempt to circumvent this requirement:

The official documents show:

• Buyer A owns 51% of the acquiring entity

• Buyers B, C, and D each own 16.33% (staying under the 20% threshold)

• All parties sign statements attesting this is the true ownership structure

The side agreement reveals:

• Buyers A, B, C, and D actually have equal 25% economic interests

• Buyer A agrees to redistribute profits according to the true ownership

• The side agreement includes indemnification clauses protecting the minority owners

This arrangement allows three of the four owners to avoid personal guarantees while maintaining equal economic rights, directly contradicting representations made to the lender.

Example: Extending Seller Involvement

SBA regulations typically limit seller involvement in the business post-acquisition to one year as a consultant or employee, with reasonable market-rate compensation. This rule aims to ensure true transfer of ownership and prevent disguised earnouts.

A common side agreement in this area might go like this:

The official documents show:

• Seller will serve as a consultant for 12 months at $120,000

• Seller will have no operational role after this period

• Seller will have no equity or profit participation

The side agreement reveals:

• Seller will continue "advisory services" for an additional 3 years

• Seller will receive 10% of profits above a certain threshold during this period

• Seller retains operational control over certain key accounts or divisions

Such arrangements directly contradict SBA requirements and the representations made in loan applications.

The Risk Spectrum: How Much Are You Willing to Gamble?

The world of side agreements isn't black and white – it operates across a spectrum of practices ranging from clearly illegal to arguably defensible:

Black Hat: Deliberately falsifying information or signing documents with the intention to deceive lenders constitutes fraud. These actions may violate:

• Federal wire fraud statutes

• SBA fraud provisions

• Bank fraud regulations

• False statement laws

Grey Hat: Some arrangements fall into murkier territory, such as provisions that technically don't contradict loan documents but still wouldn't be approved if disclosed. These often exploit perceived loopholes or ambiguities.

The consequences of discovery can be severe:

• Immediate loan default and acceleration of the entire loan balance

• Federal prosecution for fraud

• Permanent debarment from SBA programs

• Civil litigation from lenders seeking damages

• Personal liability for individual signatories

Detection Methods: How Side Agreements Get Discovered

Lenders and the SBA aren't naive about side agreements. Common discovery methods include:

1. Post-default investigations: When loans go bad, lenders investigate thoroughly and often uncover side arrangements.

2. Operational inconsistencies: When business operations don't match the official transition plan, lenders start asking questions.

3. Disgruntled party revelations: When relationships between transaction parties deteriorate, previously hidden agreements often come to light.

4. Financial anomalies: Unexplained cash flows or accounting entries may trigger audits.

Anonymous tips: The SBA maintains fraud hotlines, and competitors or employees sometimes report suspicious arrangements.

The Ethical Crossroads: Alternatives to Consider

While side agreements persist in the marketplace, there are legitimate alternatives to achieve similar business objectives:

1. Transparent negotiation: Many lenders will accommodate reasonable modifications if approached directly and honestly.

2. Alternative financing structures: Non-SBA financing may offer more flexibility for certain deal structures.

3. Earnest renegotiation: When SBA requirements truly create business obstacles, working with SBA officials to request exceptions may yield better long-term results.

Creative but compliant structures: Experienced transaction attorneys can often develop structures that accommodate party needs while remaining within regulatory boundaries.

The Bottom Line: Risk vs. Reward

Side agreements remain common in the acquisition marketplace, particularly in SBA transactions where regulatory requirements may feel restrictive. However, the risks associated with these arrangements are substantial and growing as enforcement increases.

Before considering any undisclosed arrangement, ask yourself:

• Is this arrangement worth the potential personal legal exposure?

• Would the business survive an immediate loan acceleration if discovered?

• Could the same objective be achieved through transparent means?

• Am I comfortable with the ethical implications of this decision?

Remember that business acquisition is rarely a one-time transaction. Your reputation and relationship with financing sources will likely prove more valuable over your career than any single deal structure.

While we cannot recommend engaging in undisclosed side agreements, we recognize the pragmatic reality that they exist in the marketplace. Business owners must ultimately make their own assessments of risk tolerance and ethical boundaries, ideally with the guidance of qualified legal counsel who understand both the letter and spirit of transaction regulations.

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