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  Inside the Business Valuation Process: A Primer for Commercial Lenders
Inside the Business Valuation Process: A Primer for Commercial Lenders

By Dan Doran

In the end, it all comes down to the bottom line. “Value,” like beauty, is subjective – what the business is worth to the owner may not be what it is worth to the market. But if a business is to be sold, its value must be objectively determined – a sticking point for the lenders involved in the transaction.
In all buy-sell transactions, valuation is the proximate issue: just how much is the business worth? From a seller’s perspective, one way to find out is to let the market speak by soliciting offers. From the buyer’s perspective, past experience might be one method to understand value, or perhaps quantifying what one can afford in terms of cash out of pocket and monthly loan payment is another.
Both of these methods tend to be imprecise. And while they may satisfy the parties – and lenders – in some smaller deals, when it comes to Small Business Administration lending, the SBA’s standard operating procedure requires that when goodwill exceeds $250,000, an independent, third-party valuation is required.
Typically lending teams within larger financial institutions are more accustomed to the valuation process and requirements. However, for a large segment of community and mid-size banks, the valuation process and related requirements may be more of an enigma where SBA loan volume is lower.
This short tutorial provides lenders with guidance on who should perform a valuation for their client, how the lender can help with selecting a valuation professional and an overview of the factors a valuation analyst will consider.

Who Can Perform the Valuation?
The SBA requires that the valuation be performed by someone who routinely performs business valuations. While this makes sense at first blush, it also segues into a recent change: CPAs are not qualified to perform business valuations in the absence of an accompanying valuation credential. Many jump to the conclusion that business valuation is a core component of CPA work. It’s not. While there are CPAs who also perform valuation work, the CPA credential on its own does not indicate that a practitioner routinely performs valuation work.
The SBA does recognize several credentials that are acceptable for third-party valuation firms. Those include:
CVA, a credential from the National Association of Certified Valuators and Analysts.
ASA, from the American Society of Appraisers.
ABV, Accredited in Business Valuation, awarded to CPAs by the American Institute of Certified Public Accountants.
CBA, Certified Business Appraiser, from The Institute of Business Appraisers Inc.

What Should Lenders
Consider When Selecting a Firm?
When selecting a firm to perform a third-party business valuation it’s important to consider the experience of the appraiser or appraisal firm. Items to look for include:
Industry experience: Does the appraiser have experience working in the given industry?
Valuation specialization: Does the appraiser routinely perform valuation work? Or merely hold a valid credential but rarely perform actual valuations?
Capacity: How long will it take to complete the project? We all know the old saying, “time kills deals.” Ideally the appraiser has capacity to turn the project around in a reasonable time – typically one to three weeks.
What Will an Analyst Consider?
Each valuation is slightly different, but the valuator will consider three approaches: the market approach, the income approach and the asset approach. Each of these approaches considers the company in a different light, allowing the appraiser to take a deep look at the business.
For SBA loan valuations, the asset approach is usually considered, but not relied upon. The asset approach essentially looks at the book value of the company, perhaps making adjustments for assets and liabilities that may not transfer to the buyer. In most common applications of the asset approach there is no goodwill. Given that the SBA requirement is predicated on goodwill, it stands to reason that the asset approach is infrequently relied upon.
The market approach seeks to compare the subject company to other similar companies in the market. This approach –
often comparing the subject company’s earnings, gross profit or revenues to other, similar companies – can provide great insights into how the market has priced similar businesses. The downside is the availability of data. Companies that fit within the SBA program are invariably not public, and data can be sparse and misleading. If the business type is common – such as day cares, gas stations or insurance agencies – market data may be robust. But finding data for less common businesses is more challenging.
The income approach seeks to develop a discount rate – essentially a risk profile – for the subject company. The advantage in doing so is that the appraiser can directly tune the calculation for the subject company. The analyst will look at the earnings stream of the company and apply the discount rate in order to develop the overall value.
While not required to rely on all of those approaches, by reviewing each the analyst is able to best triangulate fair market value. A good analyst will be able to select the best approach and model for the subject company to develop a fair market value.

Are There Common Pitfalls to Avoid?
Perhaps the most common pitfall in valuing businesses in concert with SBA lending is understanding which assets and liabilities are conveying to the purchaser. (This also happens to be an area that can derail deals when buyers and sellers do not clearly convey expectations). For example: is the seller retaining accounts receivable and accounts payable? Or is the buyer purchasing? How about real estate rental deposits? Or prepaid expenses? Accrued vacation?
Identifying which assets and liabilities will be part of the “NewCo” balance sheet early will help both the analyst properly prepare a valuation, as well as ensure buyer and seller are on the same sheet of music at closing time.

Where Can Lenders Go for More Information on Valuations?
The SBA SOP 50-10 5(b) recently added more extensive business valuation requirements to ensure that lenders are utilizing qualified and compliant valuation analysts. Lenders may also consult the websites of The National Association of Certified Valuators and Analysts and the American Society of Appraisers for more in-depth information on the valuation process, such as IRS Business Valuation Guidelines and an International Glossary of Business Valuation Terms. ■

Dan Doran, CVA, is principal of Quantive Business Valuations, a professional business valuation practice specializing in small to medium-sized closely held and family owned businesses.


Posted on Tuesday, November 03, 2015 (Archive on Monday, February 01, 2016)
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