Business Valuations
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.
Having a valuation in hand before the acquisition loan process begins is helpful but not necessary. Valuations for advisory businesses or client assets are fairly predictable for the majority of deals when the seller’s revenue is under $2 million.
Lenders do not require a valuation at the beginning of the process. In fact, the valuation is a closing item requirement. This means that the acquisition loan can be fully underwritten and approved before the valuation is completed. In these cases, the buyer and seller have agreed upon an estimated price based upon a multiple on revenues. When the valuation is completed then there might be an adjustment.
If the buyer is using an SBA loan then the loan can’t exceed the valuation amount. If the buyer is willing to pay more than the valuation the difference is typically paid out to the seller through a seller promissory note. If the buyer is using a conventional loan then there is more flexibility in financing the full amount of the purchase even when the valuation is less than the purchase price. Conventional lenders will use a combined LTV as the determining factor.
Valuations When an SBA Loan is Involved
Ordering the Valuation
Conventional lenders will typically accept any recent business valuation created by a known valuation firm in our industry like a FP Transitions or Key Management Group.
SBA lenders however, must be the ones that order the valuation and 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.
Valuations When Using an SBA Loan
When it comes to valuations under SBA loans, precision and adherence to guidelines are paramount. SBA loans require that the valuation amount strictly limits the loan amount; if the purchase price exceeds this valuation, the buyer must typically make up the difference via a seller promissory note. This contrasts with conventional loan scenarios, where there's more leeway to finance the entire purchase price, even if it exceeds the valuation, provided the deviation is reasonable.
Numerous third-party companies specialise in valuing businesses for Financial Advisors. However, it's vital to note that not all valuation firms have approval from every lender. For SBA loans, lenders often insist on managing the valuation process themselves to ensure compliance and accuracy.
When dealing with SBA valuations, the lender must order and engage the valuation, ensuring it is tailored for their requirements. The valuation report needs to be thorough and include whether the transaction involves an asset or stock purchase, explicitly detail what is included in the sale, list any assumed debt, and culminate with a conclusion of value. Moreover, the report should feature the qualifications of the valuator and include a signed certification page.
Importantly, the lender can't rely on appraisals commissioned by the buyer or seller. The costs linked to these valuations are usually passed on to the Small Business Applicant, ensuring the process remains transparent and fair.
When is the Process is the Valuation Required?
For an SBA loan buyer:
When the estimated value of the buyer's practice is crucial for avoiding a cash down payment, immediate valuation is prudent. For instance, an advisor with annual gross dealer concessions (GDC) of $300,000 and no business debt will likely meet the valuation requirement easily for a $5 million SBA acquisition loan. In contrast, an advisor aiming to acquire a $2.5 million practice with only $100,000 in GDC should seek an early valuation. This precaution ensures that any potential shortfall in valuation, which may necessitate a significant cash down payment, is identified early, giving room for financial planning or renegotiation.
Valuations When Using an SBA Loan
Banks typically don't require valuations before proceeding with the acquisition loan application process.
Valuations are almost always required as a closing condition. This flexibility allows advisors to wait until loan approval before commissioning or requesting the bank to order a valuation, especially in situations where the valuation's outcome is unlikely to complicate the approval process.
Valuation or pre-qualification first: The loan pre-qualification term sheet comes first from a lending perspective. While it is nice to have the valuation before an offer is even made that’s not the norm. For the buyer who needs a loan for the purchase it doesn’t really matter what a seller’s practice values at if they can’t get a loan for the purchase price.
For an SBA or conventional loan seller:
Early valuation is also advisable when the sale price significantly exceeds what might be considered reasonable to external valuers. With SBA loans, the loan amount cannot surpass the appraised valuation. For conventional loans, while some discrepancy between the purchase price and valuation might be acceptable, it should not breach the lender's loan-to-value (LTV) criteria. In these cases, early valuation helps in confirming whether the proposed deal aligns with financial expectations and lending requirements, potentially avoiding any last-minute hurdles or renegotiations.