3 Common Misconceptions Borrowers Believe (and Lenders Have to Unwind)

3 Common Misconceptions Borrowers Believe (and Lenders Have to Unwind)

by | Aug 26, 2026 | SBA Business Valuation and Appraisal

Securing an SBA 7(a) or a conventional bank loan to acquire or expand a small business is one of the most powerful leverage tools in commercial finance available to grow businesses. However, nothing derails an acquisition faster than a fundamental disconnect between buyer expectations and SBA or bank valuation guidelines. Lenders are often forced to perform the delicate work of unwinding those misconceptions late in the underwriting process.

Below is a breakdown of the three biggest SBA valuation and bank loan valuation myths borrowers believe—and the reality behind how most bank lenders and all SBA lenders and certified business appraisers actually evaluate deals. 

MYTH #1: “My CPA said it’s worth X.”

The Misconception:

Borrowers often enter deal discussions armed with a valuation provided by their local CPA, bookkeeper, or tax accountant. They assume that because a Certified Public Accountant handles tax returns and financial statements, their opinion of business valuation is standard and binding for bank financing.

The Reality:

Tax accounting and SBA business appraisal are completely different disciplines.

  • Specialized Accreditation Required: Under SBA guidelines (SOP 50 10 8), when an independent business valuation is required, it must be performed by a qualified independent third-party holding specific accredited valuation credentials—such as a Certified Valuation Analyst (CVA), Accredited in Business Valuation (ABV), or Accredited Senior Appraiser (ASA). Standard CPAs rarely hold these specific accreditations.  The business valuator must provide a report that meets standards.  These are usually more comprehensive than what a CPA would provide.
  • Tax Minimization vs. Enterprise Value: A tax CPA’s primary objective is tax strategy—legally minimizing taxable net income. In contrast, a business valuation appraiser focuses on normalized future cash flow and risk-adjusted enterprise value. Tax return numbers cannot simply be multiplied by a rule-of-thumb heuristic without accredited valuation methodology.

Lender and Borrower Insight: Recognize the limits of an informal CPA quote or low-level informal appraisal when structuring an offer. Recognize that a formal valuation may find different values and be ready to rework the transaction when necessary. 

MYTH #2: “The bank sets the value.”

The Misconception:

Buyers frequently believe that the bank arbitrarily chooses a valuation figure or deliberately under-appraises a business to reduce its lending risk exposure.

The Reality:

Bankers and lenders do not subjectively set valuation numbers—they enforce strict SBA regulatory requirements and rely on independent appraisers.

  • Strict SBA Mandates: Under SBA regulations, an independent third-party appraisal by a certified valuation expert is mandatory whenever the transaction value (less real estate) exceeds $250,000, or in non-arm’s length transactions (e.g., buying out a partner or family member).
  • Third-Party Independence: The appraiser operates as an independent, neutral third party. The bank cannot dictate the final value to the appraiser, nor can they arbitrarily change the appraiser’s certified valuation figure once completed.
  • Cash Flow & Debt Service Rules: Even if a valuation meets the purchase price, the lender must independently verify that the business generates sufficient cash flow to cover debt service (typically requiring a minimum 1.15x to 1.25x Debt Service Coverage Ratio / DSCR). (Increasing on October 1, 2026 to 1.25x Debt Service for acquisitions verified from prior earnings, not projections.)

Lender and Borrower Insight: The bank acts as a guardian of compliance and long-term cash flow viability, not an arbitrary price-setter. Independent third-party appraisal standards and verifiable historical cash flow determine the true ceiling on value.

 

MYTH #3: “Add-backs are unlimited.”

The Misconception:

Sellers and brokers often present long lists of proposed “add-backs” to inflate Seller’s Discretionary Earnings (SDE) or adjusted EBITDA—adding back everything from discretionary travel, auto leases, and family cell phone plans to one-time repairs and projected future growth.

The Reality:

SBA underwriters and accredited appraisers apply rigorous, conservative scrutiny to all proposed add-backs.

  • Verifiable: To be approved, an add-back must be explicitly documented on official tax returns/financial records, reasonably provable and meet strict criteria. NOTE:  the valuator cannot “guarantee” the dollar value of all ad backs as valuators are NOT auditors and do not perform buyer due diligence.  (For transactions over $3 million in value SOP 50 10 8.1 effective October 1, 2026 is going to require a quality of earnings report which is not an audit but is a reasonably comprehensive review of cash flows.)
  • Management Normalization: In determining some valuation cash flows the valuator may add back the entire owner salary and personal perks. But, in most of those cases the bank underwriter must deduct a realistic market replacement salary for a manager or the future owner to run operations post-acquisition.
  • No Speculative or Future Add-Backs: Projections, unrecorded cash revenue, or anticipated future operational synergies cannot be added back to historical earnings. SBA valuations are strictly rooted in historical, tax-verified financial performance.  If there was a doubt, the new SOP 50 10 8.1 explicitly specifies historic data is to be used.

Lender and Borrower Insight: Do not use unverified expenses to justify a higher purchase price if the deal relies on SBA loan approval—all expenses must be supported by official tax returns, invoices, or accounting records.

After 50 Years of Uncertainty, ESOP Trustees Finally Have a Safe Harbor

After 50 Years of Uncertainty, ESOP Trustees Finally Have a Safe Harbor

by | Jul 21, 2026 | ESOP Business Valuation

Since ERISA was enacted in 1974, trustees have carried the weight of a simple but frustrating question:

What exactly qualifies as “adequate consideration” when purchasing closely held company stock?

The Department of Labor never issued definitive regulations answering that question. Instead, trustees often found themselves operating in an environment many describe as “regulation by litigation,” where lawsuits, investigations, and hindsight frequently shaped expectations more than written rules.

That’s why the Retire Through Ownership Act (S.2403 / H.R.5169) is being welcomed as one of the most significant developments in ESOP history.

Rather than leaving trustees to guess where the regulatory goalposts might move next, Congress has created a statutory safe harbor that finally provides a consistent valuation framework. It doesn’t eliminate the fiduciary responsibilities—but it does provide something trustees have been asking for since the 1970s: clarity.

One Valuation Standard Instead of Moving Goalposts

One of the biggest challenges trustees have faced is the absence of a consistent definition of fair market value under ERISA.

The new law addresses that problem by amending ERISA’s definition of “adequate consideration.”

In practical terms, trustees may now rely in good faith on an independent business valuation prepared using the principles established in IRS Revenue Ruling 59-60—the valuation guidance professionals have relied on for decades.

This is important because it aligns ERISA with an already well-established IRS valuation framework. Instead of wondering whether regulators might apply a different standard years after a transaction closes, trustees now have a much clearer roadmap to follow.

What Doesn’t Change

While the new safe harbor is welcome news, it doesn’t mean trustees can simply accept every appraisal without asking questions.

The fiduciary responsibilities under ERISA remain exactly the same.

That means a trustee still needs to:

  • Hire a qualified, independent valuation professional.
  • Make sure the appraiser receives complete and accurate information.
  • Read the valuation report carefully.
  • Ask questions when assumptions or conclusions don’t make sense.
  • Document the review and decision-making process.

The law protects trustees who exercise diligence and act in good faith—not trustees who simply rubber-stamp an appraisal.

Lower Liability Risk

Perhaps the biggest benefit is greater legal certainty.

Historically, trustees have worried that years after a transaction closed, regulators could challenge the valuation using standards that weren’t clearly defined when the deal occurred.

The Retire Through Ownership Act reduces that uncertainty.

When an independent appraiser follows Revenue Ruling 59-60, and the trustee performs proper fiduciary oversight, demonstrating “adequate consideration” becomes much more straightforward.

That should provide trustees with significantly greater confidence during transactions.

The DOL Still Has a Role

The legislation doesn’t remove the Department of Labor from the picture.

The DOL still has authority to issue regulations related to the Act.

However, the law does place limits on that authority. It doesn’t expand the Department’s regulatory powers or allow future administrations to create entirely new valuation standards that undermine the safe harbor established by Congress.

For trustees, that’s another welcome layer of predictability.

Why This Matters Beyond Individual Transactions

The impact of this legislation reaches well beyond reducing litigation risk.

For years, many experienced professionals and institutional trust companies have been reluctant to serve as ESOP trustees because of the potential liability.

Greater legal clarity should encourage more qualified fiduciaries to participate in the ESOP marketplace.

Business owners may also feel more comfortable considering an ESOP as an exit strategy. With a clearer valuation process, transactions are likely to become more efficient, less costly, and potentially easier to insure.

Ultimately, that’s good news for everyone involved in employee ownership.

What Trustees Should Do Next

Even with the new protections, now is a good time to review your valuation process.

Ask yourself:

  • Does your valuation firm clearly document its use of Revenue Ruling 59-60?
  • Are your engagement letters and reports consistent with the new law?
  • Are your meeting minutes demonstrating thoughtful review and active oversight?
  • Is your documentation strong enough to show you fulfilled your fiduciary responsibilities?

The safe harbor provides important protection, but good documentation remains one of your strongest safeguards.

A Long-Awaited Turning Point

For decades, ESOP trustees have operated in an environment where the rules often seemed uncertain and the risks difficult to predict.

The Retire Through Ownership Act represents a major shift toward clarity and consistency.

It doesn’t lessen the importance of being a careful fiduciary. Instead, it rewards trustees who follow a sound valuation process and make thoughtful, well-documented decisions.

That’s good news for trustees, good news for business owners, and most importantly, good news for the employee-owners whose retirement security depends on well-managed ESOPs.

 

 

 

How to Legally Reduce Tax Liability Through Valuation Logic

How to Legally Reduce Tax Liability Through Valuation Logic

by | Jun 10, 2026 | Estate and Gift Tax Business Valuation

If you’ve ever looked at a business valuation and thought, “That number seems low,” you might have just stumbled upon one of the most powerful tools in estate tax planning.

In the world of gift and estate taxes, a lower valuation isn’t a bad thing—it’s a strategy. By applying specific “valuation discounts,” savvy business owners and their advisors can legally reduce a business value by anywhere from 10% to 45%.

Here is how the logic of “Fair Market Value” translates into impressive tax savings.

The “Willing Buyer” Logic

Business valuations for gift or estate purposes use fair market value as a standard of value.  Fair market value is a defined term in business valuation.  Fair market value stresses that the buyer and seller are both hypothetical and not the same as the buyer and seller.[i]

To understand discounts, you have to look through the eyes of the IRS’s favorite imaginary person: the Hypothetical Willing Buyer.

Imagine someone offers to sell you 10% of a family-owned landscaping business. You’ll have no say in how the company is run, you can’t force a dividend payment, if you work there you can still be fired, and you can’t easily sell your shares to someone else because there’s no public and a very limited private market.

Would you pay the full “sticker price” for those shares? Of course not. You’d demand a discount for the headache of having no control and no exit strategy. The IRS and courts recognize this economic reality.

The Two Heavy Hitters: DLOC and DLOM

When we talk about reducing tax liability by approximately 35%, we are usually talking about stacking two specific types of discounts.

Discount for Lack of Control (DLOC)

This is often called a “minority discount.” If you own less than 50% of a typical partnership or corporation, you can’t fire the CEO, set your own salary, or sell the company’s assets.[ii] Because you lack “control,” the value of your specific shares is worth less than a proportional slice of the whole pie.

  • Typical Range: 5% to 25%

Discount for Lack of Marketability (DLOM)

If you own stock in Apple stock, you can sell it in seconds and receive the money in three days. If you own stock in “Bob’s Manufacturing, Inc.,” it might take you six to nine months to find a buyer and another three months to close the deal. That delay and uncertainty converting the business to cash create a “marketability risk.”

  • Typical Range: 10% to 35%

How the Math Works (The “Stacking” Effect)

Discounts aren’t added together; they are applied sequentially. This is where the big savings happen.

Let’s look at a quick example:

  • Enterprise Equity Value:  The control, marketable value of the equity of a company is $10,000,000.  You own a 10% lack of control, unmarketable share of a business.
  • Your pro-rata value: before discounts is $1,000,000.  But you have no control.  In addition, private companies are hard to sell and take time.
  • Apply DLOC (20%): The value drops to $800,000.
  • Apply DLOM (25%): You take 25% off the new $800,000 figure, bringing it down to $600,000.

In this scenario, with properly performed work, you’ve legally reduced the taxable value of that business interest by 40%. If you are gifting that stock to your children, you just moved $1M worth of value while only using $600k of your lifetime gift tax exemption.  Now, any future value growth is in your children’s trust or accounts, not yours.

The Legal “Guardrails”

While these discounts are powerful, you can’t just pick a number out of thin air. The IRS and the courts are highly skeptical of “round numbers” that aren’t backed by data. To make a discount stick, you need a professional valuation report from a qualified appraiser that properly cites and calculates one or more of the below methods[iii] to determine marketability:

  • Restricted Stock Studies: Data showing what investors pay for non-tradable shares.
  • Pre-IPO Studies: Comparing prices of stock before and after a company goes public.
  • The Mandelbaum Factors: A specific set of legal criteria used by courts to judge marketability.
  • Statistical Studies:  Modeling of various Put Option Contracts are used to justify marketability.
  • QMDM, Stout DLOM Calculator, Stout and Aldering/Hitchner have developed methodologies using Stout data.

With tax laws constantly under review many families are using these discounts to “freeze” the value of their estates today. By gifting discounted shares now, all the future growth of that business happens outside of your taxable estate.  Minimize taxes with thoughtful planning. 

[i] We apologize for this simplification of fair market value for this article.  We could write several blog posts on fair market value alone.

[ii] You must read the documents.  Most entity types have flexibility in structure and control may not be determined by percent of ownership.

[iii] There are also other methods.  A comprehensive guide on Marketability discounts is “Discount for Lack of Marketability Guide and Tookkit by Jim Hitchner, Jim Aldering, Josh Angell and Kate Morris.

Why Two Similar Businesses Can Receive Very Different Valuations

Why Two Similar Businesses Can Receive Very Different Valuations

by | May 20, 2026 | SBA Business Valuation and Appraisal

Business owners are often surprised when two companies that look very similar on the surface receive very different valuations.

  • The revenue may be comparable.
  • Profit margins may be close (but often they are not).
  • Both companies may even operate in the same industry.

So why would the valuations come out differently?

The answer usually comes down to risk and sustainability. Valuation analysts are not just looking at what a company earned last year—they are evaluating how dependable those earnings are going forward.

The following underlying factors can push a valuation higher or lower, even when the financial statements appear nearly identical.

Industry Risk

Not all industries carry the same level of stability. Even a well-run company can face valuation pressure if it operates in a sector that lenders view as volatile or cyclical. For example, businesses tied to construction, hospitality, or discretionary consumer spending may experience significant swings during economic slowdowns whereas people continue to buy food and obtain medical care.

Valuators and lenders consider questions like:

  • How sensitive is the industry to economic cycles?
  • Are there regulatory risks or technological disruption?
  • Is demand cyclical, stable or highly seasonal?

A company operating in a higher-risk industry may receive a lower valuation multiple than a similar business in a more stable sector.

Greg likes to say, "concentrations kill." Below are a few concentrations.

Geographic Concentration

Two companies might have identical revenues, but one may draw customers from multiple regions while the other depends heavily on a single local market.

Heavy geographic concentration can raise concerns such as:

  • Local economic downturns
  • Population shifts
  • Regional regulatory changes
  • Local competition pressures

Geographic diversity often creates a more resilient revenue base.

Customer Mix

A business that serves hundreds of small customers may present less risk than a company where a few clients account for most of the revenue.

Valuators pay close attention to issues like:

  • Customer concentration – Does one client represent a large percentage of revenue?
  • Contract structure – Are relationships secured with contracts or informal agreements?
  • Customer diversity – Are customers spread across different industries?

A balanced customer base reduces the chance that losing a single relationship will significantly impact the business.

Management Bench Strength

A business that depends heavily on the owner—or one key individual—creates uncertainty for lenders and buyers.

Questions that often arise include:

  • Who manages operations day-to-day?
  • Who maintains key customer relationships?
  • Who makes strategic decisions?

A company with a strong management bench tends to receive stronger valuations because it signals continuity and stability.

Final Thought

The numbers tell only part of the story.

The rest of the story is about risk, resilience, and the ability of the business to thrive under new ownership. Companies that demonstrate stability across these areas often see the difference reflected in their final valuation.

Repurchase Obligations: Why Every ESOP Company Should Be Planning Ahead

Repurchase Obligations: Why Every ESOP Company Should Be Planning Ahead

by | Apr 18, 2026 | Estate and Gift Tax Business Valuation

One of the most common—and most misunderstood—issues I see when working with ESOP companies is the long-term impact of repurchase obligations. While repurchase liability doesn’t show up on the balance sheet and isn’t classified as debt, it represents a very real future cash requirement that can materially affect liquidity, financing flexibility, and ESOP sustainability if it is not actively managed.

Ultimately, the key question every ESOP company needs to answer is how it can balance competing demands: funding repurchase obligations, servicing debt, maintaining operations, and continuing to invest in growth.

At its core, a repurchase obligation is the company’s requirement to buy back shares from ESOP participants when they become entitled to distributions—most commonly at retirement, death, disability, termination, or through diversification elections. Those shares must be repurchased at fair market value as determined by an independent appraiser. The challenge is that the timing and amount of these future payments are inherently uncertain, driven by employee demographics, stock value growth, and plan design decisions that may have been made years earlier.

This is why repurchase obligation studies are so important. A well-prepared study is not just a spreadsheet exercise. It is a long-term projection of expected distributions and the related company cash requirements, designed to help management and trustees understand how today’s decisions affect tomorrow’s liquidity. In my experience, companies that treat repurchase planning as an ongoing strategic exercise are far better positioned to align ESOP outcomes with broader corporate goals such as earnings stability, cash flow management, and long-term value creation.

Plan design and distribution policy play an outsized role in shaping repurchase outcomes. Decisions around when distributions begin, whether they are paid in lump sums or installments, and whether participant accounts are segregated into cash can dramatically accelerate or defer cash demands. Diversification rights add another layer of complexity, as participant elections are influenced by factors such as company stock performance, communication and education efforts, and the availability of other retirement assets. Similarly, the method used to satisfy repurchases—recycling, redeeming, releveraging, or a combination—has meaningful implications for cash flow, share allocation timing, and future valuation.

From a credit and valuation standpoint, repurchase obligations sit in an unusual place. Lenders increasingly focus on projected repurchase payments when assessing free cash flow and covenant compliance, and many banks now expect to see a formal repurchase obligation study as part of their underwriting process. At the same time, repurchase liability should not be treated like traditional debt in valuation analyses. Subtracting it directly from equity value risks double-counting, since the obligation ultimately represents the value of the company’s own shares. The more appropriate approach is to understand how repurchase obligations affect future cash flows, leverage capacity, and the company’s ability to reinvest in the business.

Thoughtful repurchase planning—grounded in realistic assumptions and revisited regularly—goes a long way toward ensuring that the ESOP remains a sustainable and value-enhancing ownership structure for both current and future participants.