Recommended Components of SBA-Related Business Appraisals
- Frontmatter and Analysis of Purchase Agreement
- identification of parties (including client and intended users), reason for valuation, standard of value and premise of value defined, etc.
- scope of work discussion vis-à-vis SBA policy and procedures and USPAP compliance
- commentary pertaining to relevant SBA policy components from SOP50-10(5)(A) and Information Notice 5000-1096
- presence and implications of stock sale versus asset sale
- pertinent LOI or purchase contract terms and conditions, including:
- allocation of purchase price, type and amount of included assets and assumed liabilities
- breakdown of deal structure (buyer cash, amount and terms of seller note and SBA loan, working capital component, etc.)
- commentary on covenant not to compete and seller employment contract (if applicable)
- other deal specific features
- verification that deal terms have not changed between start of valuation and completion of valuation
- discussion of seller’s reason for sale
- Company Analysis
- company history (operations and financial performance), including role played by and compensation of seller(s) and seller(s)’ family members
- overview of buyer’s background including relevant managerial, entrepreneurial or industry experience
- depth, breadth and credibility of buyer’s business plan and cash flow forecast
- clarification of post-closing changes which will impact future revenues and expenses (profits), e.g. seller employment, elimination of franchise, acquisition of liquor license, etc.
- post-closing role and compensation of buyer and buyer’s family members or partners
- Review of product/service/customer base/accounts receivable/collections, etc.
- discussion of competitive environment in relevant market space, including analysis of key competitors and subject firm competitive advantage
- evaluation of key personnel, payroll burden, employee turnover, etc.
- analysis of subject premises, lease terms, type and value of equipment, planned capital expenditures, need for additional space to foster growth, etc.
- Financial Analysis
- trend, common-size, ratio and comparative analysis to industry norms for revenues, gross profits, operating profits and discretionary earnings (historical and projected)
- analysis of primary operating expenses and operating expense margin (historical and projected)
- detailed discussion and development of normalized earnings, e.g. adjusted cash flow for “return on owner’s labor” perspective and normalized earnings or cash flow for “return on investment perspective
- presentation and discussion of key balance sheet accounts including trend, common-size, ratio and comparative analysis to industry norms
- identification and evaluation of “hard assets” and “intangible assets” included in pending deal, e.g. inventory, furniture, fixtures and equipment and real estate (if pertinent) as well as patents, tradenames, customer base and other “on balance sheet” intangibles PLUS consideration of intangible assets “created” through the planned transaction
- presentation, discussion and analysis of buyer’s submitted cash flow forecast for purposes of determining first year normalized earnings and first year debt repayment capabilities
- adjustment to submitted forecast if not deemed accurate, sufficiently detailed or credible
- Industry Analysis
- definition and description of target industry or industries, including relevant SIC or NAICS code for classification and benchmarking purposes
- review of historical, current and projected industry trends and developments from the perspective of how they will impact the subject firm’s future revenues, expenses and profits
- identification and evaluation of multiple industry forecasts as they pertain to subject firm’s target niche and projected revenues and profits
- Economic Analysis
- review and analysis of local, state, regional, national or global economic climate and forecasts as they relate to target firm activities and future revenues, expenses and profits/cash flows
- additional data and analysis of a demographic nature involving historical and projected rates of growth in income levels and population
- consideration of other company or industry-specific economic applications such as calculation of the price or income elasticity of demand
- Valuation Analysis
- overview and discussion of available valuation methods and the selection process used by the appraiser to identify most pertinent applications (normally from the income, market and asset approaches to business valuation)
- identification of key documents, information sources, interviewees, etc., as they relate to valuation analysis
- presentation of key assumptions and limiting conditions which underlie applied valuation analysis
- inclusion of Certification Statement in accordance with USPAP and other professional standards
- application of selected valuation methods including formal presentation of detailed descriptions as to how cash flow figures were calculated and how pertinent multiples/cap rates were derived and applied
- situation-specific consideration of unique value-determinants such as the “size effect”, the “franchise premium”, the “absentee owner premium”, etc.
- clarification as to nature of generated estimates of value, e.g. minority versus controlling interest, marketable or non-marketable basis, asset deal value or equity deal value, all cash or based on normal financing terms, etc.
- Valuation Synthesis and Conclusion
- presentation of valuation results obtained in prior section with goal of “synthesizing” multiple results into a single and final estimate of fair market value
- transformation of final value estimate into purchase agreement equivalent form to allow “apples to apples” comparisons, i.e. final estimate of equity value for comparison to stock purchase deal price
- identification and summarization of key assumptions, limiting conditions and other relevant considerations related to the interpretation of the final value estimate
- Appendix Items
- Service Agreement
- Appraiser Bio
- Additional Company or Industry Coverage
- Invoice for Services Rendered
While attempting to balance the need for credible and accurate valuation results with the higher costs associated with comprehensive appraisal work, there may be certain criteria which could be used to help make the proper trade-off in this regard.
However, the analysis put forth with respect to the sample “restricted use” report would be unlikely to have led to the discovery and/or analysis and/or interpretation of the following types of circumstances which are routinely addressed in my appraisals (irrespective of the term used to describe their reporting format).
The next list includes examples of relevant and important deal-related circumstances, events, conditions, etc., which are less likely to be discovered OR reported upon in a restricted use appraisal report.
Important but Often Lacking
SBA-Related Appraisal Content or "Red Flags"
- Buyer's cash down payment, e.g. if only 10% versus 20% or 30%.
- Proper evaluation of earnout provisions (if applicable).
- Deal involves related parties or company employees/close friends.
- In addition to number 1, 2 and 3 above, a full review and analysis of the purchase agreement should be performed (including any updated versions or last minute changes which impact the "value" paid for and received by the purchaser).
- Buyer lacks documented entrepreneurial experience and/or direct industry experience.
- Business type/category has above average SBA default or charge-off rate based on current data.
- Loan is under-collateralized relative to norm or to some other benchmark.
- Buyer's projected revenues and earnings during first year are more than 15% higher than the most recent historical performance or the average from the three most recent years.
- Buyer submits forecast which is not carefully documented with assumptions that are supported by fact or other relevant information.
- Business generates more than 50% of revenues or earnings from a single customer or a single contract.
- Future success of business depends in large part on the continued presence of the seller (for at least the one full year that is allowed under the new SOP).
- Business is a "cash business" with revenues that may not be properly documented.
- Sum of owner perks and other miscellaneous adjustments exceed magnitude of straight profits (excessive addbacks).
- Seller's license was suspended due to fraudulent or illegal behavior.
- Key employee may leave after sale of business.
- Covenant not to compete addresses ONLY current customers.
- Failure to justify the selected report type in conjunction with the valuation purpose involving SBA-guaranteed financing.
- Etcetera, Etcetera, Etcetera
In closing, there is a way to manage costs and obtain complete, self-contained business valuation reports which properly serve the interests of the lender, the SBA, the borrower and the US taxpayer. Although it requires a "concession" on the part of appraisers which amounts to a lower than average hourly compensation rate, the advantages of steady work tend to overwhelm the lower appraisal fees. During these trying economic times, in particular, it is incumbent on all of us to do our part to keep the US economic train on track and moving forward - but at a safe speed with well-maintained equipment.
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