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SBA Lending Increasing, Driving Up Demand For Business Valuations

Changes under the American Recovery and Reinvestment Act (ARRA) to Small Business Administration (SBA) loan programs have recently led to a rebound in SBA-backed loans for small businesses, many of which require the lender to obtain an independent business valuation from a qualified source. Learn how an increase in SBA lending has driven up demand for business valuations.

To begin, let’s take a more in’depth look at the two most common SBA loan guarantee programs: 7(a) and 504 loans. These two guarantee programs have distinct characteristics and requirements.

7(a) Loan Guarantee Program

The 7(a) Loan Guarantee Program is the SBA’s primary program to help start-up and existing small businesses obtain financing when they might not be eligible for business loans through normal lending channels. The name comes from Section 7(a) of the Small Business Act, which authorizes the SBA to provide business loans to American-owned small businesses. The SBA itself does not make the loans, but rather it guarantees a portion of the loans that are administered by commercial lending institutions.

There are four major 7(a) loans:

- Express Programs

- Export Loan Programs

- The Rural Lender Advantage Program

- The Special Purpose Loans Program.

In order to be eligible for a 7(a) loan, the Small Business Applicant must be: an operating business; organized for profit; located in the United States (includes territories and possessions); be able to meet the SBA definition of “small”; and be able to demonstrate a need for the desired credit.

504 Loan Guarantee Program

The 504 Loan Guarantee Program is a long-term financing tool for economic development within a community. It provides small businesses requiring “brick and mortar” financing with long-term, fixed-rate financing to acquire major fixed assets for expansion or modernization. A Certified Development Company (CDC) is a private, non-profit corporation set up to contribute to the economic development of its community. CDCs work with the SBA and private sector lenders to provide this financing to small businesses.

Typically, a 504 project includes:

- A loan secured from a private sector lender, with a senior lien covering up to 50% of the project cost;

- a loan secured from a CDC (backed by a 100% SBA-guaranteed debenture with a junior lien covering up to 40% of the total cost; and

- a contribution from the borrower of at least 10% of the equity.

Proceeds from 504 loans must be used for fixed asset projects, such as:

- Purchasing land and improvements, (including existing buildings, grading, street improvements, utilities, parking lots and landscaping);

- construction of new facilities or modernizing, renovating or converting existing facilities; and

- purchasing long-term machinery and equipment.

The 504 program cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing.

In order to be eligible for a 504 loan, the business must be operated for profit and fall within the size standards set by the SBA. Under the 504 program, the business qualifies as “small” if it does not have a tangible net worth in excess of $7.5 million and does not have an average net income in excess of $2.5 million, after taxes, for the preceding two years. Loans cannot be made to businesses engaged in speculation or investment in rental real estate.

Deal Volume has Increased Substantially in Response to Federal Support

As part of the American Recovery and Reinvestment Act (ARRA), the SBA received $730 million to help small businesses. These initial funds were issued on February 17, 2009, and were exhausted within nine months, on November 23, 2009. A second allocation of $125 million was provided by Congress in December 2009 that was exhausted by late February 2010, at which point an additional $60 million was provided. This subsequent extension allowed the SBA to continue to waive loan fees and provide higher guarantee levels through April 30, 2010. This also culminated in a weekly SBA loan dollar volume increase of more than 90% in the SBA’s 7(a) and 504 programs over the period from February 17, 2009 to April 23, 2010.

This additional funding and encouragement through ARRA resulted in more than 1,253 additional lenders providing SBA-guaranteed loans during the time period of February 17, 2009 through April 23, 2010. These were lenders that had previously issued SBA-guaranteed loans but had been inactive since 2007 or earlier. The SBA has also expanded 7(a) loan eligibility to more than 70,000 small businesses through a temporary alternate size standard.

After months of reduced activity and lower premiums, SBA data suggests that the 7(a) secondary market is picking up and premiums are beginning to recover. From June 2009 to March 2010, the average monthly loan volume settled from lenders to broker-dealers in the 7(a) secondary market has been $340 million. This has provided lenders with additional liquidity to increase lending. This deal volume means additional work for lenders and business valuations appraisers.

When are business valuations required to support an SBA loan?

Certain requirements for business valuations exist for both 7(a) and 504 loans. The SBA requires the following:

- a real estate appraisal (if the SBA-guaranteed loan is greater than $250,000 AND is collateralized by commercial real property);

- a fixed asset appraisal (if the market value of the assets is greater than the depreciated value); and

- a business valuation (in cases of a change of ownership where the amount being financed including any 7(a), 504, seller, or other financing minus the appraised value of the real estate and/or equipment being financed is greater than $250,000);

- or if there is a close relationship between the buyer and seller.

According to SBA guidelines, “the lender must obtain an independent business valuation from a qualified source” when one is required. A qualified source is an individual who regularly receives compensation for business valuations and is either:

- Accredited by a recognized organization; or

- a licensed CPA who conducts the business valuations in accordance with the Standards for Valuation Services published by the American Institute of Certified Public Accountants (AICPA).

The appraisal reports for SBA loan guarantee purposes need to be compliant with the Uniform Standards of Professional Appraisal Practice (USPAP) and the SBA’s Standard Operating Procedures 50-10(5)(b), as required by the SBA. The business valuations must also consider all three approaches to value (cost, market, and income), and quantify and support the ultimate business valuation or machinery and equipment conclusion.

7 Tips For Running a Side Business

As a CPA who works primarily with small businesses and start-up businesses, I have decided to put together a list of the Top Tips for Running a Side Business.

1) Incorporate. The #1 most overlooked tip by people running side businesses is that they fail to setup a business entity because they still view their business as a “little side business” that they will incorporate “when things take off.” Here is why this is the most detrimental mistake that a side business owner can make:

-Sole Proprietorships (the business structure you default to if you fail to setup a Corporation, LLC, etc) are subject to the highest audit risk out of all the business structures. The reason for this high audit risk is that all Sole Proprietorships report their business income and expenses on Schedule C (the second most highly audited form that you can attach to your tax return. By setting up an S Corporation, you become nine times less likely to be selected for a random IRS audit (audit risk decreases from 2.7% to.3%, making it very possible that you can go your entire life without ever being selected for an audit)

-Sole Proprietorships are subject to the highest tax rates. As a Sole Proprietor, you end up paying your regular income tax rate plus an additional 15.3% Self Employment Tax. This means that if you are in the 25% tax bracket, you are essentially paying 40.3% tax. S Corporations typically enjoy a lower tax rate due to payroll taxes taking the place of Self-Employment Taxes. So, if you are in the 25% tax bracket, you end up paying somewhere between 25% and 40.3% depending on the nature of your business, profit levels, etc.

-Operating a Sole Proprietorship means that your personal assets are completely exposed during your business operations. If someone sues you for a business related matter, you could end up losing your house, your savings, your retirement, and everything else you own. By setting up an S Corporation, you protect your personal assets from business related lawsuits and all you can lose are the business assets.
By failing to setup your Corporation right from the start, you lose valuable credit-building time. Banks, credit card companies, and other lenders will not lend unsecured funds to Corporations within their first two years in business. They will either lend to you and allow you to use the funds for business purposes or they will lend to the business as long as you are willing to attach a personal guarantee. If you incorporate right from the start, when you are ready to turn your side business into a full business, you may already have this two year period behind you and you can start looking for business loans and business credit cards.

2) Do not use your home address or a PO Box. There is such a stigma associated with using a residential address or a PO Box as your business address. Many consumers view the use of a home address as a sign that you are new in business and that your business is not successful. While this may be the furthest from the truth, a consumers mind will be made up once they see your address and decide not to call you, giving you no opportunity to explain why you operate your business out of your house. In order to combat this, many business owners opt to go the PO Box route. However, PO Boxes have their own stigma. Many consumers view companies that use PO Boxes as “fly-by-night” companies that may leave town at the drop of a hat and that they may never be able to get a hold of once their job is done. Some ways around this include:

-Renting a small office within the office a client, friend, associate, vendor. In addition to giving you a consumer-friendly address to use, situations like this may also open up opportunities for more referrals due to the traffic that your landlord’s business is bringing past your door each day.

-Renting office space or a mailbox within a Virtual Office such as HQ Global, Regus, or Intelligent Office. In addition to the mailbox/mailing address options, most of these Virtual Offices offer the use of Conference Rooms, Receptionist Services, and office space as your business grows

-Renting a mailbox at a UPS Store or Mailboxes Etc. While this is nothing more than a “PO Box” located at a UPS Store instead of at the Post Office, it does give you a more consumer-friendly business address

3) Don’t skimp on professional services. When you run a side business, the #1 goal is typically to keep costs as low as possible until the business takes off and starts generating some real revenue. However, know when to DIY and when not to DIY. Certain things can be done effectively using the DIY approach, while others could prove more detrimental:

-Do not try to be your own lawyer. Free legal forms that you download on the web will leave you getting exactly what you paid for and could lead to the end of your business if you are not properly protected
Do not try to be your own accountant. While bookkeeping is a task that can be taken on by most business owners (assuming they actually have the time to devote to it), when it comes to actual tax return preparation (payroll, sales tax, corporate tax returns, etc.), deadline watching, and staying current on tax law changes, you need a CPA who specializes in small business accounting and taxation

-Do not try to be your own marketing department unless you have a true gift for it. I cannot tell you how many flyers, postcards, mailings that arrive at my house and at my office that appear as if they were designed by a child (and not a child who is destined for a great career in marketing). Between typos, plain text, black & white coloring, nothing eye-catching, poor grammer, no call to action, every penny that gets spent designing, printing, and mailing these “marketing” pieces is not only wasted, but actually create a negative image for your business, doing more harm than if you simply didn’t send out the mailing.

4) Network. Network. Network. The hands down, single most cost-effective marketing technique is networking. In most cases it is either free or $5, $10, $15, $25 per event and it will generate more business than any $1,000 print ad or $500 mailing. By networking, you are meeting potential clients/customers and potential referral sources face-to-face while getting your company’s name out there. Many networking events run in the early morning or in the evening, so you can certainly coordinate these events around your full time job.

5) Establish a web presence. Every business out there will benefit from having a web presence. Creating a website (not a freebie, amateurish looking site, but a very clean, very informative site) is a must in today’s marketplace. Just about every business owner I know has gotten at least one client/customer who just happened to stumble upon their website while searching or browsing the web. The keys are to keep the site informative, make it easy for potential clients/customers to contact you, and offer online payments through PayPal or another well-known credit card processing company. Creating your website in blog format or linking a blog to your website is a surefire way to generate traffic and ensure that visitors return at future dates to see what you have been posting.

6) Don’t play up the fact that this is a side business. Of course, if a potential customer asks, you shouldn’t lie to them. However, if the topic never comes up, you always want to “play the part” and instill confidence in your customers that you are an expert in your field, you are going to do a great job for them, and that you will be around for a long time. Now, there are some exceptions here…there are some industries in which running a side business may actually be more attractive to some customers. For things like handyman services, electrical work, carpentry, plumbing, etc., many homeowners like to hire guys who work in their field full-time during the day and then offer their services direct to the homeowner via their side business at very low rates. For a job that a contractor may bid out a $2,500, a homeowner may be able to find a carpenter who is willing to work at a $200/day rate and finish up the job in 5-6 days, leaving them with a $1,000-$1,200 bill and a $1,300-$1,500 savings for the same (or sometimes even better) quality of work. So, if your industry is similar to this, you may actually want to play up the fact that you are operating a side business

7) Create a plan. No, I’m not talking about the clich├ęd “Business Plan,” I’m talking about a “Milestones Plan.” As a small business CPA, many people are surprised to hear that I am not a proponent of entrepreneurs creating business plans. I view business plans as the #1 barrier to starting a business and that 95% of the time, once you start your business, you end up going in a completely different direction than you had originally planned as you discover your strengths, your weaknesses, what your customers want, what the economy is dictating, etc. Far too often, I see people who want to start a business, but create the “I’ll start up as soon as I’m done writing my business plan” excuse. If you have an idea or a skill and you know how to put that skill to use or bring that idea to market, just get started and everything else will fall into place. When I refer to a “Milestones Plan,” I am talking about setting concrete milestones that will dictate your timeline over the next few years. Start off by setting the following milestones and add/adjust again a few months after your business gets off the ground:

-Set a “shut down” milestone. Determine at what point you should pull the plug on your business. This can be a financial milestone (once you invest $10,000 and don’t see any potential for profitability) or a time milestone (if after 24 months, you don’t see any potential for profitability)

-Set a “part-time” milestone. Determine at what point you will convert your full-time job into a part-time job so that your side business can turn into a part time business. This can be a financial milestone (once you hit $5,000/month in revenue, once you hit $1,000/month in profit, etc) or a customer-driven milestone (once you start getting two new customers/week, once you have 25 customers, etc.)

-Set a “full-time” milestone. Determine at what point you will quit your part-time job and start running your business full time. This milestone will be similar to your “part-time” milestone, just with the bar set at a higher level.