The SBA and the Price of Entrepreneurial Risk

Entrepreneurs without ready access to equity capital are using SBA Debt, taking massive risk, and getting financially ruined in the process - locking many out of the game. Is it good for society to prevent risk takers from taking risk for decades?

TLDR:

• SBA acquisition debt has surged in recent years and require an unlimited personal guarantee that often follows entrepreneurs after the business fails: deficiency, liens on personal assets, bankruptcy risk. Equity failure in venture usually ends at the company and the investors.
• At similar company size (~$5 to $10M revenue / ARR), a search CEO vesting into ~20 to 30% and a Series B founding team near ~23% look close on percentage ownership. Preferred and debt change the economics underneath.
• Growth follows capital: Series B companies still raising are often underwritten to ~80 to 120%+ YoY growth; search targets grow on cash flow under debt service and covenants; broader private SaaS medians sit closer to ~20 to 30% YoY.
• Last five years: U.S. venture ~$1.3T of equity-heavy capital vs SBA 7(a) ~$150 to $160B of guaranteed debt. Different products. Equity scales without attaching every failure to a household and often preventing re-entry
• Search should fund more like venture: more equity, longer holds, less closed-end exit pressure. The SBA and lenders should modernize the credit box. Unlimited personal guarantees are an old credit-risk tool. They should not be the default price of productive risk. Reserve personal liability for clear fraud and abuse, with bright-line rules. Honest failure should end at the company and the capital providers, not the household. The taxpayers are already taking the risk; the banks are not.
• It is not in the national interest to shrink the entrepreneur pool by making rational people sit out. Entrepreneurship is already hard. Over-punishing honest failure is what punitive systems do. GEM puts fear of failure near ~45% in the U.S. and ~65% in China among people who see opportunities but will not start. Gallup finds ~50% of aspiring U.S. entrepreneurs name personal financial risk as a top barrier. We need a middle path that creates more founders, not fewer.

People talk about raising capital as if all capital is the same. It is not. Debt with a personal guarantee and equity that can go to zero are different instruments with different personal consequences. Much of the confusion in entrepreneurship comes from treating them as interchangeable.

There is a simple question at the center of small-business acquisition finance: Who should bear the risk when a business fails?

The current SBA lending system answers that question differently from the venture-capital system.

In venture capital, the investor provides equity, the company uses the money to operate and grow, and the investor accepts that the investment may become worthless. The founder can lose the business and the value of his or her equity, but the failure of the company does not ordinarily become a personal debt owed to the venture fund.

Under a typical SBA-backed acquisition, much of the capital is debt. The borrower is generally required to personally guarantee that debt, and the guarantee can extend beyond the value of the business itself. A business failure can therefore become a personal financial obligation.

Both systems are intended to finance entrepreneurship. They distribute the risk very differently and at extremes that are silly when contrasted.

I believe this difference is important because the United States has developed a very effective mechanism for financing the creation of new companies through equity capital while relying on a much more punitive mechanism to finance the acquisition of existing companies. The result is that a person who wants to start a software company may be able to obtain millions of dollars of risk capital without pledging a house, while a person who wants to buy an established business may be required to put the household balance sheet behind the transaction.

That is not an argument against SBA lending. It is an argument that the credit structure should be reconsidered.

A simple comparison

Consider two entrepreneurs.

The first starts a software company and raises $10 million from venture investors. The investors receive preferred stock. The company spends the capital on employees, product development and sales. Suppose the company eventually fails.

The entrepreneur has probably lost several years of work, whatever salary he or she was receiving, and the value of the common stock. The investors lose their $10 million.

Now consider another entrepreneur who buys an established company for $10 million with 75% debt, a seller note and a relatively small equity contribution. The company later fails and its assets are worth $5 million.

The equity investor in the first example loses the investment.

The entrepreneur in the second example may lose the equity investment and still owe money on the debt. Because of the personal guarantee, that obligation can extend to personal assets.

The businesses may have failed for essentially the same economic reason: the future cash flows were worth less than the parties expected.

The consequences for the individuals are very different. And that the difference is the ability to try again vs being forced to sit on the sidelines.

Personal guarantees change the nature of the risk

An SBA 7(a) loan is a bank loan. The SBA guarantees a portion of the lender's loss. It does not guarantee the entrepreneur's success. Under the standard SBA structure, individuals owning 20% or more of the borrower generally provide an unlimited personal guarantee. When the business assets are insufficient to repay the loan, the deficiency can therefore become a personal obligation of the borrower. The lender may also take available collateral, including personal assets where applicable.

This distinction is easy to underestimate when looking only at the purchase price or the buyer's ownership percentage.

Suppose an entrepreneur buys a $16 million business with approximately $11 million of senior debt, a seller note and several million dollars of equity. If the company performs as expected, the leverage increases the entrepreneur's return on equity. If the company performs poorly, the same leverage works in the opposite direction. That is normal. The unusual part is that the business risk can continue after the business has failed.

Once the company's assets have been sold, the remaining obligation does not necessarily disappear. The borrower may need to repay the deficiency, negotiate a settlement or use bankruptcy protection. Liens and other secured claims can complicate that process. The consequence is that a commercial loss can become a household balance-sheet problem.

This is a much larger economic risk than simply losing the capital invested in the company.

Venture capital is a different choice

Venture capital is not safer. In many respects, the underlying businesses are much riskier.

A venture investor may knowingly invest in a company with no profits, no established market and no certainty that the product will work. The expected return is generated by the small number of companies that become very valuable.

The important point is that the capital structure accommodates that uncertainty and equity absorbs the loss.

When a venture-backed company fails, the shares can become worthless. The founder may lose the company, the job and the economic value of years of work. But the preferred equity investor does not ordinarily convert the failed investment into a personal claim against the founder's house.

This is not an accident. It is the fundamental purpose of equity capital. The investor is paid to bear the residual risk of the company. The price of doing so is ownership and the possibility of losing the investment.

The founder is also an equity holder and therefore participates in that loss. The key distinction is that the failure remains principally within the corporate capital structure.

The comparison becomes more interesting at similar company sizes

Comparisons between venture-backed founders and acquisition entrepreneurs are often made at very different stages of company development. That can make the economics difficult to understand.

A founder of a pre-revenue startup might own most of the company. That tells us very little about the economics of owning 20% to 30% of a mature company with several million dollars of earnings.

A more useful comparison is to look at companies at roughly similar revenue levels.

The 2026 Stanford Search Fund Study places the median U.S. and Canadian search acquisition in the 2024-2025 cohort at approximately $8.1 million of revenue and $2.5 million of EBITDA, with a median purchase price of approximately $16 million. The draft compares that with a venture-backed software company in the general range of $5 million to $10 million of ARR, which would often be around the Series B stage. Carta data cited in the draft places the median founding team at approximately 23% after a Series B. Traditional search managers frequently receive approximately 20% to 30% of the equity, typically subject to vesting and hurdles.

The percentages can therefore look surprisingly similar. But the capital structures are not when debt is involved.

The venture founder has generally sold part of the business in order to obtain additional equity capital. The company may continue to invest heavily and operate at a loss because the purpose of the capital is growth.

The search entrepreneur has purchased an existing company. The company may already generate substantial cash flow, but that cash flow now has to support the acquisition financing.

This creates an important distinction. A venture-backed company can choose to spend another dollar on hiring because it expects the investment to produce a future dollar of enterprise value.

An acquisition financed with substantial debt has to ask a different question: can the company spend that dollar and still make its required debt payments?

Debt does not prevent growth, but it places a hard claim on cash flow ahead of equity.

Capital structure affects growth

This helps explain why venture-backed companies can pursue much higher growth rates than companies financed primarily with acquisition debt.

The venture model is designed to tolerate operating losses in exchange for the possibility of a much larger future business. Equity investors provide capital today and wait for the residual value.

Acquisition debt works differently. Principal and interest must be paid on a schedule. The company must therefore produce sufficient cash flow to service the debt while also funding working capital, capital expenditures and growth.

That makes the acquisition business inherently more dependent on the quality and predictability of current cash flow.

The draft's comparison of the two markets makes this point. Series B companies that continue to raise capital are often operating at very high growth rates, whereas search acquisitions are generally underwritten on existing cash flow and more modest earnings growth. Broader private SaaS growth rates are materially lower than the growth rates commonly associated with companies still raising venture capital.

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They finance different kinds of businesses. But the financing structure should match the risk.

The United States has an enormous equity market for entrepreneurial risk and the Govt is not helping with SBA structures

The difference in scale is also instructive.

The figures assembled in the draft show approximately $1.3 trillion of U.S. venture investment from 2021 through 2025, compared with approximately $150 billion to $160 billion of SBA 7(a) gross loan approvals over the corresponding fiscal years. These are different financial products and the periods do not line up perfectly, but they demonstrate the relative scale of the two markets.

The country has a very large market for financing entrepreneurial risk through equity. That market works because investors are willing to accept failure as part of the portfolio.

There is no reason that the same basic economic principle cannot be applied more broadly to the purchase of ordinary American businesses.

The problem is that search and acquisition entrepreneurs have relatively limited access to that type of capital. In its place, the market often supplies debt.

Debt is useful. It is also unforgiving. A business that misses its plan by 10% can often survive. A highly leveraged business can have much less room for error because the lender's payment does not change when the company's earnings do.

The entrepreneur therefore has two forms of exposure when borrowing from the SBA. First, there is the risk inherent in operating the company. Second, there is the financial risk created by the capital structure.

The SBA guarantee can add a third layer by connecting the company's failure directly to the entrepreneur's personal balance sheet.

The question is not whether entrepreneurs should bear risk

An entrepreneur should have substantial economic exposure. Society lets them consume the upside as a result. There is little reason to structure an acquisition in which the operator can lose nothing.

The more useful question is whether the operator should bear unlimited downside for a business loss that was incurred honestly.

There is an important difference between fraud and failure. Someone who falsifies financial statements, diverts loan proceeds, conceals material information or intentionally strips collateral has committed misconduct. Personal liability is entirely understandable in those circumstances.

An operator who buys a business based on reasonable information, operates it honestly and nevertheless loses the business has done something different.

The current guarantee structure does not always make that distinction meaningful enough. That matters because the purpose of an economic system should not be merely to prevent losses. Risk-taking creates value precisely because some investments fail.

A person who is willing to risk several hundred thousand dollars to buy a company may reasonably decide not to do so if the downside is the loss of several million dollars of household wealth.

The result is that the personal guarantee can also change the set of people willing to become entrepreneurs when they dont have access to venture capital.

There is a better use of equity capital

The answer is not to replace SBA lending with venture capital. An established plumbing company, manufacturer or healthcare services business should not be financed like a software startup. The potential return profile is quite different.

The lesson from venture capital is narrower. More of the risk should be borne by capital that is explicitly priced to take risk and less punitive for the risk taker.

That could mean more equity and equity-like capital beneath acquisition debt. It could mean lower leverage in situations where the cash flow is less predictable. It could mean limiting personal guarantees rather than making them effectively unlimited. And it could mean reserving personal liability for clearly defined misconduct.

The objective would be to preserve meaningful operator ownership while preventing an ordinary business failure from becoming an unlimited household liability. That is a different system from removing accountability. It is simply a different allocation of accountability.

Search has something to learn from venture

The same principle applies to the way acquisition capital is structured over time. A large number of small companies are not businesses that need to be sold again in five years. They are businesses that can be owned for 10, 20 or 30 years.

The traditional private-equity model is often built around a finite fund life and an eventual exit. That can be appropriate for many businesses, but it is not necessarily the natural structure for a durable operating company.

Patient capital changes the incentives. An owner who expects to hold a company for a very long time can make investments whose payoff may take years. The owner can endure an unusual downturn without immediately needing to sell. The company can retain more of its cash and reinvest when opportunities arise.

Venture capital has demonstrated the usefulness of long-duration equity capital for company creation. Search and acquisition entrepreneurship should incorporate the parts of that model that make sense for established businesses.

The SBA should modernize the credit box for small business buyers

The SBA should therefore think about the problem as a question of capital allocation rather than simply loan volume.

The government is already assuming risk through its guarantee. Banks are already making loans within a government-supported framework. The entrepreneur is already contributing equity and accepting the possibility of losing it.

The remaining question is how much additional risk should be imposed through an unlimited personal guarantee. There is no reason the answer has to be binary.

The system could continue to support bank lending while encouraging greater use of equity capital, reducing leverage in appropriate transactions and limiting personal guarantees for borrowers who have operated honestly.

Personal liability for fraud and abuse should remain. Ordinary commercial failure should be treated differently.

The broader economic question

This matters beyond the individual borrower.

Ownership of small and midsize businesses is one of the principal ways in which people become business owners in the first place. A person does not need to invent a new technology company to be an entrepreneur. Buying a profitable business and improving it is also entrepreneurship.

The capital system should encourage capable people to do both.

Venture capital has shown what happens when a country develops a deep pool of capital willing to absorb entrepreneurial failure at the company level. The United States now finances extraordinary amounts of company creation with equity.

The acquisition market has not developed an equally deep source of risk capital. Instead, much of the burden is placed on debt, and much of the downside of that debt can ultimately sit with the individual entrepreneur.

That is a poor trade if the objective is to maximize productive entrepreneurship.

The goal should not be to make business failure painless. Failure is a necessary consequence of taking risk, and entrepreneurs should expect to lose capital, time and sometimes the businesses they build.

The goal should be to make sure that the consequences of failure are allocated to the people and institutions that knowingly chose to finance that risk.

Venture capital already provides a working example. An investor can lose 100% of an investment. A founder can lose 100% of his equity. The company can disappear. The system survives because the loss ends there.

The SBA has an opportunity to adopt the same principle in a form appropriate to Main Street: more equity, more patient capital and a credit structure in which honest failure is primarily a loss to the business and its capital providers rather than an unlimited claim on the entrepreneur's household.

That would not eliminate entrepreneurial risk and it would allocate it more rationally.

The capital structure of a business is also the risk structure of the entrepreneur. The United States has learned how to finance risk through equity. The next question is whether it can apply the same principle to the people who buy and operate the small businesses that already exist and are the life blood of the economy.

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Thesis Capital's publication for news and commentary on M&A, ownership transitions, and the lower middle market. Delivered weekly.

Author

Ian Reynolds

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