See which franchises have the most SBA 7(a) loans outstanding and their default rates. In addition see which franchises have the highest Small Business Administration Loan default rates.
While a particular business may fail for many reasons one of the benefits of a franchise is name recognition and business systems. A high default rate may indicate that the business systems are not resilient and effective. Make sure you both know the value of the business you are buying (we are business valuators providing SBA business valuations after all) and know how successful other owners are.
A key tobuying or selling a business is the ability of the buyer to obtain the money for the business acquisition. Many business purchases or business acquisitions will be financed by a Small Business Administration, SBA 7(a) loan. Here are the major steps to obtain SBA 7(a) financing for purchasing a business and several great resources if you wish to learn more.
Pull together your financial statement. Here is a link to an SBA Financial Statement Form to use
Gather 3 years of your personal and if you own a business, business tax returns.
If married, talk to your spouse. In most cases they will have to co-sign the loan. If they are not willing to do this bring this up early with the bank. It may prevent you from obtaining a loan.
You may want to get per-qualified from a bank. The banker will look at your information and help you understand the size business that is realistic for you to finance. In all cases the financials of the business will impact and may change this preliminary analysis.
Obtain any other information requested by the bank loan officer packaging the Small Business Administration loan. There are likely to be many necessary documents.
Next, armed with some idea of the loan you are qualified to get go out and find a business to buy. This is a process. Figure it is likely to take six to nine months and will be a lot of work. Once you identify a business you want negotiate a letter of intent (LOI) with the Seller. A LOI is a preliminary outline of the business terms that your business purchase will be based on. Armed with the LOI go back to your SBA loan officer and….
Provide the letter of intent to the SBA loan officer
Provide three years Tax Returns for the Selling Business
Prepare a forecast and business plan for the next three years for the business finances.
Once you have made a full application with the SBA lender for the SBA small business loan there will be many other things for you to do.
The lender will obtain an SBA Business Appraisal or SBA Business Valuation. This business appraisal confirms that you are paying within the range of Fair Market Value for the business. It means the price you are paying is within the range of a fair deal. It does not mean you are getting a great deal.
Do your own due diligence. Hire an accountant to go through the books and records and tie cash to the banks and source documents and a check basis. Check out the condition of assets, talk to key people, talk to suppliers, etc. Make sure you are buying what you think you are buying.
If you have a letter of intent negotiate the full Binding Purchase Agreement. Make sure you hire an attorney that is familiar with business transactions in the state you are in.
When the day comes, go to closing……Congratulations on your new business and new SBA (7(a) business acquisition loan.
SBA 7(a) and other SBA programs provide a huge source of debt funding to increase your leverage or buying power. For most individuals buying a small business the 7(a) program is the only source of debt funding. The SBA makes loan guarantees to banks for qualifying buyers and businesses that reduces the bank risk to a level where the banks can lend. For details see – SBA, Buy an Existing Business or Franchise https://www.sba.gov/business-guide/plan-your-business/buy-existing-business-or-franchise and How to Finance an Acquisition Using an SBA Loan https://www.entrepreneur.com/article/358292
In some situations there are other forms of financing. For instance some businesses can be purchased with Asset Financing such as loans secured by Accounts Receivable or Real Estate financing. Other, extremely stable businesses like medical and dental practices may be purchased with conventional financing. For multiple possibilities see US Chamber of Commerce, How to finance a business acquisition: https://www.uschamber.com/co/run/business-financing/financing-buying-an-existing-business and CNBC, Secure financing with these 9 types of small business loans https://www.cnbc.com/select/small-business-loan-types/.
The Art of Business Valuation and Harvest Business, LLC have performed 100’s of business valuations for SBA 7(a) purposes and directly for buyers and sellers who want to know the value of the business they are buying or selling. If you have any questions please send us an email today.
Improved listening will Improve Your Leadership and Sales Results Improving Business Value
Roberto constantly meets with prospects and in machine gun fashion proceeds to tell them why he is the best tax accountant (you could put contractor, banker, auto shop….) and how he will save them money. Most politely listen and then, after 45 minutes to an hour politely find a way to leave the meeting without a full proposal or commitment to work with him.
Contrast this with Cynthia who briefly explains that she would like to address the prospect’s specific needs therefore it is best for her to start with some questions. She then proceeds to ask questions and listen in order to carefully assess their needs, budget, likely competitors in order to put together a succinct plan of action to address their specific problem. Most of her meetings result in an engagement.
Clearly an effective sales increases business value by improving the resiliency of the company.
Below is Cynthia’s secret to success –
Listening is a lost skill. It is through listening that we can truly understand others. People long to be listened to therefor effective listening will improve all your relationships and increase your value and your business value to your clients and others important to you.
What we think we “know” often gets in the way of true understanding. This happens in our businesses and in all parts of our lives. For instance, every now and then my assistant comes to me with a great idea, yet I “know” she is going to have a complaint, usually about technology. My knowing does not help either of us. Do situations like this happen to you?
A few steps to listen better:
Recognize that you have a “view.” Sort of like if you put pink glasses on. For a while everything seems pink. Then you get used to it and do not see it but it is there. That is one version of a view. My knowing as explained above is another version of a view. We all have views of everyone we “know” and almost instantly of everyone we meet.
Consciously let your view go. While doing this take 3 deep breaths and exhale slowly.
Ask your question or let the other person speak.
When they speak just listen to them very intently. Do not think about your next question or your response. Just listen.
While listening note the tone of their voice, their body language, and facial expressions. Pay attention to what is being said and what is not being said.
One more time – Listen to the answer carefully. Do not be thinking about your next question. Your next question will be better if it comes directly out of the answer just given. You can take a moment or two and think between questions. It will be interpreted as you are really listening and absorbing. Everyone likes being listened to.
Seek the answer behind the answer. What is really driving the results you see? What could change those results positively and negatively? The child’s question, “why” is remarkably powerful for digging deeper.
Listening attentively means that besides noting the response, summarize, paraphrase, and ask new open ended questions to draw out answers. If an issue is emotional in nature, empathize. Work with the person. Develop a relationship that will foster greater openness with you.
This listening skill takes an incredible amount of effort if it is not your habit. But, if you practice and train and become good at listening you will improve all your relationships including leadership and sales raising your value to all. This will improve both your personal value to your clients and your business value.
Sample SBA 7(a) Business Valuation / SBA Business Appraisal Report is provided below. Our reports are completely compliant, reasonably priced, easy to order and have a quick delivery time.
Business valuations that are compliant with the SBA SOP (Small Business Administration, Statement of Policy) are quite technical. In SBA business valuations it is generally agreed that the “Fair Market Value” standard of value is to be used. Conclusions or Opinions of Value are to be issued. According to the AICPA, a Conclusion or Opinion is issued when ALL work necessary to fully understand the value in the professional judgment of the valuator has been done.
Every valuation is going to be different. One of the primary responsibilities of the valuator is to select proper cash flows and the best methods for a given business. But, the below SBA Business Valuation is a reasonable sample and fully compliant with AICPA, NACVA, USPAP and SBA SOP standards.
The best a business valuator can do is issue an “Opinion” as to business value. As such there is always the possibility of mistakes or error in business valuations.
These seven, “easy to miss errors” in business valuation can cause the business valuation opinion of value to be unsupportable or wrong. Whatever your business valuation purpose, ESOP, SBA, litigation, or estate work, make sure you know what to look for when reviewing a business valuation.
#1 – Did the Valuator use good professional judgement in the business valuation?
Business valuations have hundreds of judgment calls and assumptions. These assumptions and judgement calls are so layered that it is easy to miss many of them. This is because business valuation is forward looking. Namely, a central tenant of business valuation is that we are trying to understand the “foreseeable” future to estimate the value of the business. Because no one knows the future we look to the past and current situation to project the future.
What possibly could be more of a judgment call than predicting the future?
In addition, since a business valuation is not an actual “sale”, we have to make assumptions about who is the buyer and who is the seller along with the timeline for the sale. This is called a Standard of Value. (More on this later.) For instance a liquidation, or rush sale will have a lower value than a fair market value sale with a full marketing period.
Therefore, as you review or prepare a business valuation look at all of (or as many as you can track) the assumptions and consider if this is a fair representation of the likely future with what is known or knowable on the valuation date. In addition, since the math used to calculate the value is influenced (or should be) by the layers of assumptions make sure the calculations and final value found also make sense for the likely future of this business.
In business valuation, always apply the common sense statement,
“I would rather be approximately right rather than perfectly wrong”
#2 – In Business Valuation, Price is NOT Value
A price is what a buyer pays a seller. It is the culmination of a sales process. That process may have been a well-managed arm’s length market sale or it may have been a personal or non-arm’s length sale such as from father to daughter. Price can only be determined by buying and selling. Price involves a huge amount of emotion, luck, and in many cases deal terms such as the seller receiving part of the price over time through payments on a note.
Value is an “opinion” based on what is known and knowable to a defined standard of value and other assumptions as of a given valuation date. Usually it is assumed that the entire value is paid in cash at closing. The past is used to reasonably and rationally estimate the foreseeable future. Calculating an opinion of value does not include emotion or quality of the sale process.
Therefore price can and usually will be above or below the value. But, the two should relate. If you can’t relate them there is probably an error.
#3 – What is “known or knowable” as of the valuation date
Businesses are ever changing. Every day there are new opportunities and challenges. Therefore valuators establish a cut-off date when preparing a business valuation. That cut-off date is called the valuation date. The valuation date is not the same as the report date. The report date is the day the report is issued.
So, if my valuation date is December 31, 2019 and my report date is June 30, 2020, the only things I am supposed to consider in the six month period following the valuation date are things that were known or “knowable” as of the valuation date. Exactly what is knowable is a professional judgment call.
Sometimes the concept of a fixed date as time passes is relaxed or the valuation date is a moving target. This is common in divorce cases. Another example; if a valuation is prepared for an acquisition and a major change occurs after the valuation date the valuation may be valid as of the valuation date, but it is probably not useful to the parties.
This may all seem like silly semantics but think of the value of a sit down restaurant in Manhattan before and after the Covid-19 shut-downs. Therefore, pay attention to what is known or knowable as of the valuation date because change is constant.
#4 – Business Valuation – Standard of Value
In business valuation Standards of Value are shorthand definitions for who is my buyer, who is my seller, whose view (buyer, seller or both) are we looking at the value from and what is the time-frame for the sale.
This standardization allows business valuations to be comparable to each other and useful to reviewers and users. Standards of value are often specified by the purpose of the business valuation.
For instance, in litigation, the state or Federal rules that apply will often specify a standard of value. Valuations for tax purposes are specified to be fair market value.
Sometimes the standard of value is selected by the client. For instance for internal planning use, a client might select fair market value or synergistic value.
A few of the most common standards of value:
Fair Market Value – “The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” Rev Ruling 59-60
Note that this is not an actual buyer or seller including the owner or prospective buyer of a business but hypothetical buyer or seller. Further assumptions are that the price will be paid in cash at closing and the sale will happen relatively quickly (namely the interest is “marketable”).
Fair Value –For small business use, this standard is generally fair market value of a 100% interest divided pro-rata by the ownership interest. Namely marketability and minority interest discounts are not applied. If a minority owner owns 7% of a business with a control value of $100,000 the value is $7,000. Under fair market value after discounts it might be $4,000. This standard is often specified by statute to protect minority interest holders in businesses.
Synergistic Value – “A price or potential price reflecting all or some portion of the value of synergistic benefits created through the combination of the respective entities” Shannon Pratt.
A simple example of a synergistic value is two delivery companies with half empty vehicles going on the same delivery routes. If they merge the value of the target should be higher to this buyer than other buyers because the combined entity will have higher earnings (fewer drivers, and fewer full trucks) than the target generates on its own. If many market buyers may have the synergy available then synergistic value can fall under fair market value. Usually it falls under investment value below.
Investment Value – This is the actual estimated value of a company to another known company or buyer. Investment Value is the opposite of Fair Market Value in that both the buyer and seller are known and the value is estimated to them as opposed to hypothetical buyers and sellers.
Along with standard of value is premise of value. There are two main premises, going concern where the company is assumed to continue and liquidation where the company is assumed to be dissolved.
Clearly assumptions specified in the standard of value can greatly affect the value found. Make sure the valuation calls out the correct standard of value for the purpose of the valuation and then applies that standard of value throughout the many assumptions, calculations and report.
#5 – Business Valuation – Cash Flow Normalization
For many people, cash flow is the main thing they think of when they think of business valuation.
For small business valuation the most frequently used cash flows are revenues, EBITDA or Earnings before Interest, Taxes, Depreciation, and Amortization, and SDE or Sellers Discretionary Earnings. SDE is essentially EBITDA plus all the ways one owner makes money including salary and benefits. Revenues are easy to identify but often do not indicate the earnings power of the company. Therefore they can be a less reliable indicator of value.
For business valuation, cash flows are first “normalized”. When normalizing the valuator attempts to adjust the cash flow to be similar to the cash flows used to develop a multiplier or discount / capitalization rate discussed below. Basically to create an “apples to apples” comparison.
Normalization involves several types of adjustments, comparability, one time or non-operating, and discretionary.
Comparability adjustments are to adjust how the company keeps their accounting records to fit the cash flow definition being used.
One-time adjustments are unusual and non-recurring expenses or revenues such as a loss from a onetime lawsuit. The valuator would remove the loss from the cash flow as they are unlikely to be predictive of future cash flows.
Discretionary adjustments are adjustments an owner may make for his benefit like having a non-working spouse on payroll. This situation may not occur with the new owner and are discretionary to the current owner.
Cash flows for the last three to five years are typically reviewed and adjusted.
Then depending on the valuation method being used the historic adjusted cash flows are weighted.
For instance if I have three years of data being reviewed for a business valuation, I could weight each year’s cash flow evenly to come up with an average or I could select one year to come up with one number for my future cash flow. The other alternative used in some methods is to develop a projection of likely future results. With small businesses this can be difficult. How the cash flow is selected or determined can greatly swing value and needs to be carefully considered.
Either way, the valuator is trying to estimate a future cash flow. Therefore even if historic results are strong but an intervening event has occurred (think Covid with sit-down restaurants, or a convenience store that lost its lease), the future cash flow may vary from the past.
In the end, cash flow in most cases is one of two major factors used to calculate an indication of value. All of the assumptions and adjustments, and perhaps even the calendar years of data (3 years or 5 years or some other figure) used to determine trends of the company need to make sense and be reasonable.
#6 – Selection of the Multiplier or Discount/Capitalization Rate
In business valuation a great deal of time and effort is spent on the financial information or numbers. But, behind the numbers is a business that generates the numbers. This business may have great systems and people and be highly resilient or it could be a few overworked people doing everything from the seat of their pants. Evaluating the business itself and what we call, “soft” factors is very important. This information is then used to determine the risk factor of the business. The risk factor is then applied against the cash flow selected to determine value. For example in the market method market comparables are reviewed against the subject company (both financial information and quality of the company) and then the starting point indication of value is determined using the formula below.
Market Method: Cash Flow X Multiplier = Value
It is easy to hedge a risk factor a little high or a little low. If the valuator also hedged the cash flow in the same direction the indication of value can be seriously different from what would be the correct value found. Therefore always apply a sniff test or judgment test to the multiplier, capitalization rate, or discount rate used.
#7 – Business Valuation – Weighting of Methods to Determine Value
Calculating the indications of value is simply applying the cash flows to the multiplier or discount or capitalization rate. Often multiple business valuation methods will be used to estimate value. Then sometimes one method is selected or the different methods will be weighted to come up with a value.
For instance the value found under the market method is $200,000 and the value found under the income method is $250,000 the valuator might pick either method or weight them. If weighted 50% each then the value would be $225,000. It is important that there be a valid logic in this weighting that ties into issues with the valuation methodologies, the overall company situation and likely future based on what is known and knowable as of the valuation date.
Finally the value estimated based on cash flows should be adjusted as appropriate for extra assets included or excluded in the valuation method assumptions. A typical adjustment could be for inventory.
For instance, with restaurants inventory under the market method is often added to the indicated price and depending on the source of comparable data.
Working capital with small businesses is another source of adjustment. In small company transactions owners often keep the working capital (cash and accounts receivable). As companies get larger working capital is more likely to be included in the price. Again, this is another area where professional judgement must be applied particularly with companies between one million and five million dollars of value.
Each method should be reviewed and the weighting itself should be reviewed for reasonableness. Any adjustments for included or excluded assets should be made and also reviewed for reasonableness. Valuation it an iterative process.
Always finish developing or reviewing a business valuation by remembering Tip 1 – “I would rather be approximately right than perfectly wrong.”
Conclusion:
Business valuations are quite technical. If it is your business and your life being affected by the valuation, or if you prepare or review business valuations, you want make sure the valuation is right.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” covers many professional judgement scenarios, explains calculations and standards in great detail and addresses other important valuation issues. You will also have web access to download sample reports, calculators and checklists. You will reach for this complete resource time and again.
