Required Business Valuations for Acquisition Loans

AdvisorLoans does not provide business valuations but they are involved with about every acquisition and acquisition loan we navigate. SBA and conventional lenders handle valuations differently both in if required and for who orders it. With rising valuations and recent changes to SBA rules lets go over the 7 most common questions we get about bank loan purposed business valuations.

1 - Do banks require a business valuation for acquisition loans?

Third party business valuations are required on the seller’s practice in most cases. Typically conventional lenders will require a valuation if the loan request is $500,000 or more and the SBA requires a valuation for for purchases of $250,000 or more.

2 - When is the valuation ordered?

Conventional lenders will typically accept any recent (within 6 months) business valuation created by a known valuation firm in our industry like FP Transitions, Key Management Group, and Truelytics. SBA lenders however, must be the ones that order the valuation and will typically do so using only the valuation firms who are on their SBA certified valuator vendor approval list. The SBA also requires that the lender orders the valuation and that the valuation is prepared for the lender. The SBA specifically prohibits a lender from using a valuation that was prepared for the buyer or seller. For SBA loans be prepared to pay a deposit to the lender before they’ll order the valuations.

Having a valuation in hand before the acquisition loan process begins is helpful but not necessary. Lenders do not require a valuation at the beginning of the process. In fact, the valuation is a closing item requirement and typically isn’t due until the end or after underwriting but typically needed for the approver or committee approval. This means that the acquisition loan can start before the valuation is ordered. In these cases, the buyer and seller have agreed upon an estimated price based upon a multiple or range on revenues or EBITDA.

3 - Which comes first loan pre-qualification or the valuation?

We don’t sell valuations we navigate and process acquisitions and the financing. Based on our perspective, a loan pre-qualification term sheet absolutely comes first as a general rule, but acquisitions are a case-by-case endeavors. While it is nice to have the valuation before an offer is even made that’s not the norm in direct acquisitions. For the buyer who needs a loan for the purchase it doesn’t really matter what the seller’s practice values at if it’s obvious they can’t get a loan for an estimated multiple purchase price. For most buyers, before they start bidding on practices they should first find out how big of a practice they can get a loan to buy. It’s smart to get an Loan Pre-Approval letter that shows how much in acquisition loan dollars the advisor can qualify for and if they would qualify for a conventional or an SBA loan.

4 - What if the valuation is below purchase price?

While conventional lenders have flexibility for this scenario, SBA lenders will not lend for an acquisition amount that is higher than the valuation. If the valuation is lower than the purchase price then the buyer needs to decide if they are still willing to pay the purchase price. If they are willing then the difference needs to be paid in cash (rarely happens) or the difference can be paid through a seller promissory note (almost always what happens). Depending on the size of the difference gap the seller note may be able to be for one to three years or for a longer period like three to seven years depending on the impact to the deal’s cash flow.

For conventional loans it is usually more about the impact to LTV or loan to value. Since the value of the buyer and seller’s practice is combined when LTV is calculated the discrepancy between the valuation and purchase price would have to be significant to throw a monkey wrench into the approval.

Tip: Address Valuation in Your LOI: It’s common to address bank financing as a contingency of an LOI but less so regarding valuations. Consider including a provision along the lines of: If the bank’s ordered valuation comes below asking price seller has option to offer seller-financing for the difference. Both parties have the option to re-evaluate or negotiate a better suiting deal at that time.

5 - Is a valuation ever ordered on the buyer’s practice?

Until the most recent changes made by the SBA this was a thing for acquisitions but I’ll spare you the explanation. Today there are no required valuations on the buyer for SBA loans. For conventional loans a valuation on the buyer would typically only be ordered when the loan is over either $5 million to $10 million depending on the lender.

6 - Who pays for the valuation?

The SBA lender is required to order the valuation. Most SBA lenders will not do this without a deposit from the borrower. For these lenders, when the buyer wants the valuations completed sooner than later the deposit is paid early instead of later in the process.

Conventional lenders typically do not order the valuation and do not care if the valuation was paid for by the buyer or seller. If the seller already has a recent (less than 6 months old) valuation in hand then this typically can be accepted. If there is no valuation in place then one needs to be ordered. Who orders and pays for the valuation for conventional loans is on a case-by-case basis decided upon between the buyer and seller. Sometimes the seller will pay for the valuation considering that if the buyer can’t qualify they will have the valuation they can use for a different buyer. Sometimes the buyer pays for the valuation to expedite the process with confidence they will be able to qualify for the loan to purchase it.

7 - What are the current multiple ranges?

AdvisorBox estimated multiple ranges based on internal experience and industry research. AdvisorBox is not a licensed business valuation firm and does not provide business valuations.

EBITA Multiple Ranges: Under $500M AUM: Range is about 4x to 6x EBITDA; $500M - $1B AUM: Range is about 5x to 9X EBITDA; and $1B - $5B AUM: Range is about 7x to 11x EBITDA.

Recurring Revenue 2.25x - 3.5x multiple: Revenue generated on a regular basis without selling something again and again. Based on a management fee which is a percentage of assets managed or taking the ongoing trail compensation from annuities and mutual funds instead of upfront. Examples would include: Fees, Annuity trails, 12b-1s, Renewals, A share mutual fund trails, and SMA / Third-Party Managed business. A share trails and SMAs will typically get slightly more premium value.

Semi-Recurring Revenue 0.50x - 1x: A segment of transactional commissions which can be shown as consistent and predictable revenue and therefore has value. Consistent = Over the last 3-5 years. Predictable = Within 10% each year. This might include more consistent commission business from stock and bonds, REITs, and UITs.

Commission Revenue 0 - 0.25x: A product is sold and a commission payment is received in full at the time, and no other ongoing compensation is earned from the transaction. Examples would include: Stocks, Bonds, REITs, and UITs and at the bottom of the range sits Life Insurance and Fixed Annuities.

Tip: Address Valuation in Your LOI: It’s common to address bank financing as a contingency of an LOI but less so regarding valuations. Consider including a provision along the lines of: If the bank’s ordered valuation comes below asking price seller has option to offer seller-financing for the difference. Both parties have the option to re-evaluate or negotiate a better suiting deal at that time.