When you seek financing to purchase a business, it is natural for the lender to take steps to ensure that the deal is sound. After all, if the business is not financially viable, you will not be able to make financing payments on time. Often, banks require that independent valuation firms perform a business appraisal before the loan closes. Learn what it means to work with a valuation firm before getting a loan to better understand this important part of the business financing process.
Is a Company Valuation Required for a Bank Loan?
Many lenders require that you have a company valuation performed by an appraiser. If your loan is backed by the Small Business Administration (SBA), they will often require an appraisal. SBA loans cannot exceed the appraised value of the business plus any real estate or equipment. Accordingly, if the SBA is lending you $125,000 to buy an auto service business, they will want to make sure that the auto service business is worth a minimum of $125,000.
The SBA has set out their own guidelines regarding business valuations. Other lenders may have similar guidelines for business appraisals prior to financing approval.
Buyers can get stressed about having a business appraisal done, because the numbers need to match for financing to be approved. In the event that the hair salon appraises at $110,000, the bank may refuse to loan the additional $15,000 needed to meet the purchase price. The buyer could then decide to raise the funds elsewhere, use personal money to make up the difference, or not proceed with the transaction.
Ultimately, the appraisal protects your interests as a buyer in addition to the bank's interests as a lender. It would not make good financial sense for you to spend $125,000 on a business that only received a valuation of $100,000, would it? It is better to know the appraised value before you buy.
What Happens During the Business Appraisal Process?
The bank may select their own valuation firm to do the appraisal or have you select a firm. Either way, the next step is for a qualified appraiser -- someone with accredited appraisal training and knowledge of the business niche -- will perform independent research on the business and review business documentation to estimate the valuation of a company.
The appraiser will select from commonly used business valuation methods, such as the asset approach, income approach, and market approach.
As a business buyer, there is not much you need to do to support the appraisal process. The business seller will work with the appraiser to furnish the documentation needed to get a business valuation. It is in the seller's interests that the appraisal meet their price too, since they want the deal to close.
When the business valuation firm concludes their appraisal, they will provide the engaging party with the report. You may also need to get a real estate or equipment appraisal completed as well which are separate reports.
If you are buying a business and are told a valuation is needed, don't worry about it. It's a standard part of the financing process, not something to stress over.