Essential Business Valuations for Acquisition Loans

Essential Business Valuations for Acquisition Loans

At LoanBox, we understand that business valuations play a crucial role in acquisition loans, even if we don’t provide them directly. Our involvement spans nearly every acquisition and loan we navigate. SBA and conventional lenders approach valuations differently, especially regarding whether they are required and who orders them. With rising valuations and recent changes to SBA rules, let’s dive into the 7 most common questions we receive about bank loan-related business valuations.

1 - Do banks require a business valuation for acquisition loans?

In most cases, third-party business valuations are needed for the seller’s practice. Typically, conventional lenders require a valuation if the loan request is $500,000 or more, while the SBA mandates a valuation for purchases of $250,000 or more.

2 - When is the valuation ordered?

Conventional lenders usually accept any recent (within 6 months) valuation from reputable firms in our industry, like FP Transitions, Key Management Group, and Truelytics. However, SBA lenders must order the valuation themselves, using only firms on their approved valuation vendor list. The SBA requires that the valuation is prepared for the lender, not for the buyer or seller. If you’re pursuing an SBA loan, be ready to pay a deposit before they’ll initiate the valuation. While having a valuation before starting the loan process can be helpful, it’s not necessary. Lenders typically don’t require a valuation at the beginning; instead, it’s a closing item that’s usually needed at the end or after underwriting for approval. This means you can start the acquisition loan process before ordering the valuation, often based on an estimated price agreed upon by the buyer and seller.

3 - Which comes first: loan pre-qualification or the valuation?

At LoanBox, we focus on navigating acquisitions and financing. Generally, getting a loan pre-qualification term sheet comes first, but each acquisition is unique. While having a valuation before making an offer is beneficial, it’s not the standard practice. For buyers needing a loan, the seller’s practice valuation isn’t as crucial if it’s clear they can’t secure financing for the estimated purchase price. Buyers should first determine how much they can borrow before bidding on practices. It’s wise to obtain a Loan Pre-Approval letter to understand the acquisition loan amount you qualify for and whether you’re eligible for a conventional or an SBA loan.

4 - What if the valuation is below the purchase price?

Conventional lenders have more flexibility in this scenario, but SBA lenders won’t finance an acquisition priced above the valuation. If the valuation comes in lower than the purchase price, the buyer must decide if they’re still willing to proceed. If they are, they’ll need to cover the difference in cash (which is rare) or via a seller promissory note (which is more common). Depending on the difference, the seller note may be structured for one to three years or even longer, depending on the deal's cash flow implications. For conventional loans, the focus is on the impact to LTV (loan-to-value). The combined value of the buyer’s and seller’s practices must be significant enough to affect approval.

Tip: Address Valuation in Your LOI: It’s common to mention bank financing as a contingency in a Letter of Intent (LOI), but less often for valuations. Consider adding a provision like: If the bank's ordered valuation is below the asking price, the seller has the option to offer seller financing for the difference. Both parties can then re-evaluate or negotiate a deal that works better for everyone involved.

5 - Is a valuation ever ordered on the buyer’s practice?

Recent SBA changes have eliminated the requirement for business valuations on the buyer for SBA loans. For conventional loans, a buyer’s valuation is typically only ordered for loans over $5 million to $10 million, depending on the lender.

In conclusion, understanding the role of business valuations in acquisition loans is essential for small business owners navigating this process. Whether you're looking to buy or sell, being informed will help you make better decisions.

6 - Who pays for the valuation?

The SBA lender is required to order the valuation. Most SBA lenders will not do this without a deposit from the borrower. For these lenders, when the buyer wants the valuations completed sooner than later the deposit is paid early instead of later in the process.

Conventional lenders typically do not order the valuation and do not care if the valuation was paid for by the buyer or seller. If the seller already has a recent (less than 6 months old) valuation in hand then this typically can be accepted. If there is no valuation in place then one needs to be ordered. Who orders and pays for the valuation for conventional loans is on a case-by-case basis decided upon between the buyer and seller. Sometimes the seller will pay for the valuation considering that if the buyer can’t qualify they will have the valuation they can use for a different buyer. Sometimes the buyer pays for the valuation to expedite the process with confidence they will be able to qualify for the loan to purchase it.

Tip: Address Valuation in Your LOI: It’s common to address bank financing as a contingency of an LOI but less so regarding valuations. Consider including a provision along the lines of: If the bank’s ordered valuation comes below asking price seller has option to offer seller-financing for the difference. Both parties have the option to re-evaluate or negotiate a better suiting deal at that time.

This article is authored by Darin Manis, founder of LoanBox.