In 2018 the Main Street Employee Ownership Act (MSEOA) was passed. It was thought the MSEOA would allow companies to get an SBA 7(a) loan for an ESOP transition. Unfortunately, the SBA requirements to secure the 7(a) loan for an ESOP transition made it unlikely that anyone to use it. They are still using a case-by-case approval process for ESOP loans. The NCEO outlines those requirements in a recent blog post.
This June, Congress introduced H.R. 8254. The Appropriations Committee report states:
Employee Ownership.–The Committee recognizes that employee-owned businesses are uniquely structured and provide wide-ranging benefits for businesses, workers, and the local economy. The Committee notes that the Main Street Employee Ownership Act, which Congress enacted in section 862 of Public Law 115-232, requires SBA to make structural changes in SBA lending programs to ease the challenges faced by employee-owned businesses in accessing financing. This legislation also requires SBA to use Small Business Development Centers (SBDCs) to establish an employee-owned business promotion program to provide assistance on structure, business succession, and planning. SBA is directed to fully implement these requirements. The Committee further directs SBA to work with the Departments of Agriculture, Labor, and Commerce to provide education and outreach to businesses, employees and financial institutions about employee-ownership, including cooperatives and employee stock ownership plans; provide technical assistance to assist employees’ efforts to become businesses; and assist in accessing capital sources. https://www.congress.gov/congressional-report/117th-congress/house-report/393
If this bill gets passed, it may create a great opportunity for businesses to sell to their employees.
There are over 30 million small businesses in the US, according to the Small Business Administration (SBA), and upwards of 50,000 small businesses are sold each year. If you are buying a small business, an SBA business valuation can get you the loan you need to buy the business. Here is what buyers and sellers need to know about SBA business valuation.
What is an SBA business valuation?
An SBA business valuation is a formal assessment of a business’s worth done in advance of the sale of a business. Buyers who want SBA loans to finance a business acquisition usually need a business valuation. The SBA guarantees loans from lenders who comply with the SBA program rules. SBA guarantees reduce the risk of loss to the lender encouraging them to lend.
The SBA rules are known as the SBA SOP or Statement of Policy. Any business purchase over $250,000 in value and any business purchase between related parties (family or business type relations) will require a business valuation from a “qualified source.”
Why do I need a SBA business valuation?
As stated in the SOP:
“An accurate business valuation is required because the change in ownership will result in new debt unrelated to business operations and potentially the creation of intangible assets. A business valuation assists the buyer in making a determination that the seller’s asking price is supported by an independent Qualified Source (see definition in Appendix 3).” (SBA SOP p 262)
What are the major points required by the SBA SOP?
The rules outlined by the SBA SOP are specific. Here are the major points for a business valuation required by the SBA SOP:
It must be requested by and prepared for the lender
It must identify if the transaction is an asset sale or stock sale.
It must be specific enough to know what is included in the sale including assumed debt if any
It must provide the valuators conclusion of value
Valuators qualifications
Valuators signature
How does an SBA qualified business valuation work?
First, a valuator with a valuation certification from an acceptable body (ASA, CVA, ABV, are a few of the accepted designations) will prepare a business valuation in compliance with valuation standards. This valuation will determine the value of the asset being purchased, and that it is within the range of a fair market value standard of value. In short, I find that the buyer is paying a reasonable amount of the asset being purchased.
Business valuation is quite complex (as I say, it is an art and a science). But, at its core, we are trying to determine that it is reasonable for the business assets (including people) to keep generating cash flows at a level consistent with the amount a buyer is agreeing to pay.
Because all businesses are unique, we adjust the company financials to be apples to apples comparisons to several different types of models. This is called normalizing the financials.
Business valuation uses comparisons. Market method approaches use actual sale transactions or stock market values to compare. Income approaches look at what an investor would pay. Asset approaches look at what the assets are worth, if sold off on their own. The valuator adjusts the financial information and then selects the base approaches to estimate the value.
Business valuators are not auditors. We are allowed to assume that data being provided is reasonable and true. Therefore, you as a buyer still need to perform due diligence to make sure the data being provided to the business valuator is true. A business valuation does not replace careful due diligence.
What do I need to do to order a business valuation?
In most cases, the lender is going to order the business valuation as this is required by the SBA SOP. (It is certainly appreciated if you ask them to reach out to us.) In most cases, the business valuator is going to need: 3 years tax returns for the company; 3 years internal financial statements; year-to-date financial statements (profit or loss statement and balance sheet); accounts receivable aging; and accounts payable aging; letter of intent or contract of sale. Most valuators have a questionnaire to cover the required management interview and to answer small but important questions. Most businesses will also have one or two other documents specific to their industry. The loan underwriter will also need most of these documents so get them early in order to not slow down your SBA loan underwriting process.
Contact me to find out more about business valuations and buying or selling your small business.
Thank you for having me. The attached slides are available in conjunction with our SBA 7(a) Loan – SBA Business Valuation Presentation. Note, the SBA often refers to business valuations as SBA business appraisals.
In our SBA Business Valuation / SBA Business Appraisal Presentation we cover the following three topics.
Very high level business valuation theory. Namely why we cannot just average the last three years financials and select a multiplier or other risk adjustment factor and come up with a value.
SBA Business Valuation particulars. What you need to know and do to get a business valuation quickly and easily.
Covid-19 aftereffects (we hope) and how we work with financial “holes” and “bubbles” etc. so you and your client can be prepared.
In addition to regular SBA 7a loans and SBA funding, businesses have been able to ask for additional funding through programs like the Paycheck Protection Program (PPP), the Restaurant Revitalization Fund, and Shuttered Venues Grant. Applications for the PPP closed on May 31 and slow rollouts of the SVG, The Wall Street Journal recently asked, “What is it small businesses actually want from the SBA?” And spoke to advocates, business owners, and the SBA about what the post-pandemic assistance will look like.
Below are the major points answering what entrepreneurs want from the SBA, or you can read The Wall Street Journal’s full article here.
Protect and Rebuild Businesses
Scott Gerber, CEO of the Community Company, told the WSJ, “Strategies might include expanding the agency’s outreach efforts to smaller, newer businesses, as well as giving more support to businesses in minority, rural and disenfranchised communities.” In response, the SBA says they are “designing pandemic-relief programs focused on businesses that are most in need.”
Provide Access to Capital
Traditional SBA loans look at credit scores, and if businesses failed to pay rent or other loans during the pandemic because they didn’t have the revenue, their credit scores have been negatively impacted and they might not be able to get loans. Small business advocates say that the SBA should relax rules for the loans, make sure the information on how to get loans is clear, and help businesses understand what they are eligible for.
Be More Inclusive
We all heard the stories at the beginning of the pandemic about who was and wasn’t getting PPP loans. Similarly, advocates are now pointing out that the SBA should “connect with small businesses that have historically been left behind.”
If you are buying or selling, or adding or removing a partner from a business partnership, you may know that the business needs to be valued. In very generic terms, this means creating a financial model of your business and estimating a value. Business evaluators use three business valuation approaches to value different businesses. But how do you know which valuation approach is best for your small business?
Here are the basics on the 3 approaches to business valuation, and which businesses they work best for.
The market approach uses substitution of market sales.
The market approach is the primary way to value small and very small businesses. The valuator will substitute comparable market sales from similar companies that have recently been sold to the company being valued. This calculation includes comparing cash flows and financial information with information about how the company is structured, the industry, and overall economy. For example, if a small government services provider is looking to determine their value for the SBA, a valuator would compare their size, management team, cash flow, and financials to a group similarly sized business in the same industry. For more information on this approach click here.
An income approach is based on cash flow.
When valuators use the income approach to find the value of a small business, they focus primarily on cash flow. The income approaches estimate the business value to an investor who could invest in anything from a government bond to a small business. This means looking at how much money a business is making and the business risk compared to other investment risks. Because most people who are buying or selling a business are interested in knowing how this business compares to other businesses this approach is the most used approach. By looking at the historic cash flow and income of a business along with many other business factors, valuators estimate future cash flow and the risk of obtaining the cash flow. From those inputs, they can estimate a value. For more information click to ….
The asset approach estimates the business’s value through assets.
For some small businesses, their value may lie in the assets they have. For a construction company, this could include equipment; for a commercial real estate company, it could include their properties; and for a tech company, it could include intellectual property. The asset approach is often used when there is not sufficient cash flow to use the income or market approach and basing the value on cash flow would not adequately estimate the value of a business. For more information on this approach click here.
The reality is that a professional valuator looks at your small business and all the available information, and uses the approach (or combination of approaches) best suited for your business. Each of these three models can be useful and each can be used in a misleading way. This is why all the models are helpful but none are perfect. As valuators, we impartially use valuation models to help business owners understand their value, whether it is for an SBA 7(a) loan approval, dissolution of the business, or establishing a partnership.
