Valuations for SBA Business Acquisition Loans

Determining the value of a business is a key aspect of an SBA lender’s underwriting process for loan applications involving a business acquisition (change of ownership).

According to SBA Standard Oprating Procedure 50-10-5(c), paragragh (i), page 179, for all business acquisition loans over $350,000, or whenever a buyer and seller have a close relationship, the lender must obtain an independent business valuation from a qualified source.  Examples of “close relationships” include transactions between: Employer-Employee; Family members; Co-Owners; and any parties that have an existing, non-arms-length relationship. A “qualified source” is an individual who regularly receives compensation for business valuations and is accredited by a recognized organization.

As Certified Business Appraiser’s (CBA’s) accredited through the Institute of Business Appraisers, Exit Strategies Group, Inc., is a qualified source for business appraisals for SBA loans.

Exit Strategies provides quality, SBA- and USPAP-compliant valuation reports within 2 weeks, at a competitive cost.

Lenders may call Bob Altieri, CBA, at 530-478-9790 to request a quote or receive a sample SBA loan valuation report.

Exit Strategies Joins National Business Valuation Group

Exit Strategies has joined forces with National Business Valuation Group, LLC, a consortium of independent business valuation and litigation support firms that have affiliated in order to provide clients with highest quality  professional expertise.  The relationship between offices allows each firm to provide its clients with technical, database, industry, geographic and consulting expertise that would not be available from typical business valuation firms.  Offices regularly communicate with each other regarding specific cases and valuation issues in order to ensure the highest quality work for clients.

Each office in the group is required to have senior level business appraisers with either Certified Business Appraiser (CBA) or Accredited Senior Appraiser (ASA) professional designations, the most coveted and difficult professional designations to obtain.

Does Size Matter in Business Valuation?

As a business broker I hear lots of interesting comments and questions about the value of businesses. Recently a business owner said to me, “Peet’s Coffee, (Nasdaq:PEET) trades for 20 times earnings, so should I be able to sell my Mike’s Coffee Company for that?” It’s a great question. Besides brand recognition and the liquidity of public vs. private company shares, size is the obvious difference between Peet’s and Mike’s. So how much does the size of a company and its earnings affect valuation multiples? Quite a lot as it turns out.  Smaller companies tend to sell at lower multiples of most financial measures than larger companies in the same industry.

Companies under $50 million typically sell for considerably lower price-to-earnings multiples than companies from $50 to $500 million, and companies over $500 million typically sell for higher multiples than those from $50 to $500 million. According to business valuation expert Shannon Pratt, who has authored many seminal works and is widely recognized as the “father” of privately held business valuation, “Larger companies are less risky, and therefore, are priced in the market reflecting lower discount rates and higher market multiples.” Conversely, the smaller the company, the lower the average market valuation multiple.

This relationship between price multiples and company size holds true for smaller businesses as well. Middle Market companies with $1 to 5 million of EBITDA (normalized annual earnings before interest, taxes, depreciation and amortization) are easier to sell and command higher pricing multiples on average than companies with less than $1 million EBITDA.  In my experience with private businesses at the low end of the Middle Market, those with higher revenue and earnings are clearly more marketable, command higher price multiples, involve less risk, and are more readily financed.

The following table illustrates the relationship between two price multiples and company revenues, using data from a study of thousands of sales of small and very small businesses across all industries:

Size of CompanySale Price / RevenueSale Price / Discretionary Earnings*
Up to $1 million revenue0.512.2
$1 to 5 million revenue0.622.9

* Discretionary Earnings is defined as EBITDA plus market compensation to a general manager (usually the business owner). It is interesting to note that in many of these very small transactions EBITDA (Discretionary Earnings less a reasonable GM salary) is actually zero or negative, and EBITDA shouldn’t be used as a basis of comparison. The purchaser essentially buys a job.

Business valuation theory is consistent with the data. In his book, The Market Approach to Valuing Businesses, Shannon Pratt says “This conclusion (that smaller companies sell for lower multiples), reached from analysis of market data, is consistent with income approach (cost of capital) research, which shows that smaller companies have higher costs of capital (higher discount rates) than larger companies. Higher discount rates in the income approach should mean lower multiples in the market approach, and this relationship does, indeed, hold true.”

Since size does affect business value, using prior transaction data or indirect industry rules of thumb derived from companies that are much larger or smaller than your company can result in incorrect conclusions about business value. Any market data used to estimate the value of your company should be limited to an appropriate size range.

So what’s at stake?

Errors in business valuation can lead to poor decisions about buying, selling, merging, gifting, tax planning, investing in or loaning money to a business. If you’re selling for example, you risk undervaluing your business and leaving hard-earned money on the table, or you risk overpricing it and wasting precious time and resources and experiencing undue market exposure and potential loss of confidentiality. For the small business owner, when making important decisions involving your life’s work and perhaps your most valuable asset, it makes sense to value it right the first time.

Al Statz, CBA/CBI, is President of Exit Strategies Group, Inc., a business brokerage, mergers, acquisitions and valuation firm serving closely-held businesses in Northern California. He can be reached confidentially at 707-778-2040 or alstatz@exitstrategiesgroup.com. – See more at: http://exitstrategiesgroup.com/blog.html?bpid=2183#sthash.gD1ch5ie.dpuf