Why You Need a Business Valuation to Qualify for an SBA Loan

According to the Small Business Administration's (SBA) Standard Operating Procedures (SOP), if the amount borrowed through a 7(a), 504, seller, or other SBA-backed financing product is greater than $250,000, excluding the appraised value of property and equipment, the business must undergo a third-party valuation.

Small businesses are the backbone of the U.S. economy, fostering job creation, driving innovation, and contributing significantly to local communities. Recognizing this critical role, the U.S. Small Business Administration (SBA) offers a range of financial products aimed at helping these enterprises thrive. Among these offerings, SBA loans stand out as a pivotal resource, providing small business owners with the funds needed to expand operations, hire more employees, or invest in new equipment.

One of the key steps in securing an SBA loan is obtaining a business valuation. This process, though sometimes overlooked, is critical to ensuring that both the lender and borrower have a clear understanding of the business’s worth. In this article, we'll explore why a business valuation is necessary when applying for an SBA loan, what the process entails, and how it safeguards both parties involved in the transaction.

Understanding SBA Business Valuations

When a small business owner applies for an SBA loan, the lender must assess the risk associated with the loan. This assessment often involves determining the value of the business. If the amount being financed exceeds $250,000, minus the appraised value of any real estate and equipment, the SBA mandates that an independent business valuation be conducted.

This requirement serves several purposes:

1. Risk Mitigation: The valuation helps the lender gauge the potential risk of the loan by providing a clear picture of the business's financial health and market value.
2. Fair Market Value: It ensures that the business is priced at its fair market value, which is crucial for both the lender and the borrower. Overvaluation can lead to larger loan amounts than necessary, increasing the risk of default, while undervaluation might limit the amount of funding the business can receive.
3. Transparency: A third-party valuation provides an unbiased assessment, which is especially important in transactions involving related parties, such as family members or business partners, where conflicts of interest could arise.

When Does the SBA Require a Business Valuation?

The SBA’s guidelines specify several scenarios where a business valuation is required:

• Financing Amount Exceeds $250,000: If the total loan amount, excluding real estate and equipment appraisals, is greater than $250,000, a business valuation is mandatory.
• Related Party Transactions: If the buyer and seller have a close relationship, such as family ties or business partnerships, a valuation is needed to ensure that the transaction is conducted at arm’s length, avoiding any potential conflicts of interest.
• Lender's Internal Policies: Some lenders have internal policies that require a business valuation regardless of the loan amount. This is often done to align with best practices and ensure the security of the loan.

The SBA Business Valuation Process

The business valuation process for an SBA loan is designed to be straightforward, yet it requires adherence to specific guidelines. Here’s an overview:

1. Lender Requests the Valuation: The lender initiates the process by requesting a business valuation. It is important to note that valuations prepared by the borrower or seller are not acceptable for SBA purposes. The lender must commission an independent valuation.
2. Defining the Scope of Work: The lender provides the valuator with detailed instructions regarding the transaction. This includes specifying whether the transaction is an asset or stock purchase and listing the components of the sale. Clear communication ensures that the valuation accurately reflects the business’s value.
3. Certified Valuation: The final valuation report must include the valuator's opinion of the business’s value, along with their qualifications and signature. The valuation must adhere to the Uniform Standards of Professional Appraisal Practice (USPAP), which sets the ethical and performance standards for appraisers in the U.S.
4. Qualified Valuator: The SBA requires that the valuation be performed by a qualified and accredited appraiser. Recognized accreditations include the Accredited Senior Appraiser (ASA), Certified Business Appraiser (CBA), Accredited in Business Valuation (ABV), Certified Valuation Analyst (CVA), and Business Certified Appraiser (BCA).

The Benefits of SBA-Backed Loans

Securing an SBA-backed loan can provide small business owners with numerous advantages, beyond just access to capital. These loans often come with lower down payments, longer repayment terms, and competitive interest rates, making them more affordable and accessible. Additionally, SBA-backed loans may include counseling and educational resources to help business owners manage their finances more effectively and grow their businesses sustainably.

However, these benefits come with the responsibility of ensuring that the business is accurately valued. A thorough and professional business valuation can make the difference between securing the necessary funding and facing loan rejection or financial hardship down the line.

Avoiding Predatory Lending Practices

While SBA loans are designed to support small businesses, it is important for borrowers to be vigilant against predatory lending practices. Unfortunately, some lenders may use unethical tactics to exploit borrowers, particularly those who are less familiar with the loan process. Key warning signs of predatory lending include:

• Lack of Transparency: If a lender is unwilling to fully disclose the costs associated with the loan, this could be a red flag.
• Demanding Access to Bank Accounts: Requiring direct access to a borrower’s bank account to collect payments can be a sign of predatory practices.
• History of Complaints: Researching a lender’s history and looking for any past consumer complaints can help identify potential issues.
• Insufficient Valuation Methods: If the lender does not use robust and recognized business valuation methods, the borrower may be at risk of receiving an inaccurate loan amount.

You can safeguard yourself from these unethical practices and obtain the best terms for your SBA loan by making sure that a qualified and accredited professional conducts your business valuation.

Conclusion

In conclusion, obtaining a business valuation is not just a bureaucratic requirement; it is a crucial step in the SBA loan process that protects both the lender and the borrower. By providing a clear and accurate assessment of the business’s value, a professional valuation helps ensure that small businesses can access the funding they need to grow and succeed, while also safeguarding lenders against potential risks.

At Business Valuation Advisors, Inc ., we provide independent business valuations for SBA loans. Our team of certified appraisers is committed to helping small business owners navigate the complexities of the SBA loan process with confidence. Whether you are seeking funding to expand your business, purchase new equipment, or refinance existing debt, a thorough and professional business valuation can be the key to unlocking your business’s potential.

To learn more or for valuation services, visit our website, www.ValuationAdvisor.com