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.