Tip of the Week
New Release of SOP 50 10 (5) A – Financing of Goodwill (or NOT)
The old adage “be careful what you ask for” is ringing pretty true this week after SBA’s release of the newest version of the SOP 50 10 (5) A (effective March 1). Upon reading the new version and comparing it to version 4, we observe that most of the changes are pretty benign. However, it only takes one change to cause a frenzy in the SBA lending community, especially in this frustrating economic environment where lending has become more and more constricted.
On page 139 of the new SOP, it states that the financing of goodwill (intangible assets) will be restricted. “In no event may the amount of goodwill financed by an SBA guaranteed loan exceed 50% of the loan amount up to a maximum of $250,000.” This seems pretty alarming when we are being told by business valuators and lenders that the majority of their business acquisition deals (historically) have included more than that amount of $250,000 (and, therefore, going forward MOST of these types of deals are not going to get done with the way the SOP reads now).
Also, on page 181, business valuation requirements have changed. BEFORE, if the loan amount exceeded $350,000, then the lender was required to have the business valuation conducted by an independent “qualified” business valuator. NOW, if the amount being financed (including 7(a), 504, seller or other financing) minus the appraised value of the real estate and/or equipment is greater than $250,000, or if there is a close relationship between the buyer and the seller, the lender must obtain an independent business valuation from a qualified source.
Lastly, SBA has now authorized a licensed CPA that performs the business valuation in accordance with the “Statement of Standards for Valuation Services” published with AICPA, to conduct the independent business valuation.
We have asked our friend and resident expert on this topic, Steve Mize with GCF Valuation ( 813-258-1668 x 2 or smize@gvalue.com), to weigh in on the topic. We greatly value his opinion and know he has expressed his insight directly to SBA, so we wanted to have him share with you the concern rising rapidly in our lending community:
It appears the SBA has blindsided the small business lending community by limiting goodwill financing to $250,000. As a regular provider of business valuations to SBA lenders, I can give real world examples why this is a mistake. The strength of a company, its management and overall business model services the bank’s debt – not tangible assets. As a lender, I would rather finance a strong service company with a diversified customer base, competent in-house management, strong cash flow margins/coverage, and minimal “tangible assets” compared to an asset intensive manufacturing company with high capital expenditure requirements, high working capital requirements, and marginal cash flow coverage. The most valuable and marketable companies in the world have significant amounts of goodwill.
In my experience, sellers of small businesses will most likely delay their decision to sell if forced to finance a large portion internally. This alone will dramatically reduce 7(a) volume and go against everything the new administration wants to accomplish. Also, larger seller notes could hinder the borrower’s ability to move forward with new ideas and processes. Lastly, seller financed notes will most likely be crammed into a 2 or 3 year term, significantly increasing the debt service and limiting working capital for future growth. This would only delay growth and job creation – not a good idea in this economy.
As a business valuation specialist, I see hundreds of acquisitions, loans and refinances annually. I can honestly say that many of the strongest performers include service businesses, professional practices and franchises, all of which have a significant amount of goodwill.
Limiting financing on goodwill will NOT minimize default rates, it may even increase them. If goodwill financing is limited to $250,000, the vast majority of business acquisitions will be eliminated, period.
CPA Issue - The SBA took a bold, but necessary step last year by recognizing “qualified sources” for business valuations. In the proposed SOP for 2009, they have added CPAs as a qualified source, which I believe is a step backwards. The AICPA and NACVA created specialty designations called the ABV – Accredited in Business Valuation and CVA – Certified Valuation Analysts, both already recognized as qualified designations in the current SOP. To acquire these two designations, you MUST already be a CPA. They originally created these designations because there is no formal training in business valuation required to obtain the CPA license.
Just because a CPA performs a business valuation in accordance with the "Statement on Standards for Valuation Services" (SSVS) does not indicate the CPA is qualified. Adding the "SSVS" language in the SOP doesn't make much sense because all CPAs are required by the AICPA to follow "SSVS". Bottom line, you can be a licensed CPA and have no business valuation training at all. By adding CPAs as a qualified source, SBA is discrediting the ABV and CVA designations - both of which were created specifically for CPAs.
Goodwill Transactions - Over the last 10 years, I have been compiling all of the transactions my firm has appraised as well as obtaining additional transaction data from our clients. Soon to be published, this database shows over 4,000 arm’s length transactions, all of which were financed by SBA lenders. Here is a summary of the transaction
detail:
Average Sales $1,332,604
Average Available Cash Flow $ 190,447
Average Transaction Price $ 708,260
Average Goodwill $ 529,862
As you can see above, total goodwill as a percentage of the total purchase price averages approximately 75%. Keep in mind, “tangible” assets in an asset sale can be severely overstated. If the SBA requires “depreciated value” or an equipment appraisal, I would certainly agree that the average small business transaction would equal 80% to 90% goodwill. Here are a few other facts from our database:
* Of the 893 professional practices, 91% of the transaction price
was considered goodwill;
* Of the 651 franchises, 86% of the transaction price was
considered goodwill;
* Approximately 25% of the businesses in our database sold for
more than $1 million. The average transaction price was $1,562,000.
The average goodwill for this group of transactions was $1,188,111 or 76%.
* The percentage of transactions in our database that had goodwill
less than $250,000 = 27%.
The above data shows that limiting financing for goodwill to $250,000 is NOT an option. If this passes, 7(a) loans in volume and dollars will decrease significantly.
We are asking lenders to communicate to NAGGL (contact Jenny at joneill@naggl.org) or to us directly, what type of impact this will have on your loan volume (how many business acquisition loans have you done historically that would not have been eligible if the goodwill restriction had been in place at the time the loan was made). Also, please tell us how these business acquisition loans are performing at this time. One of our clients (a national lender) told us this week that 34 of their small business customers for a total of $29,900,000 in loans would not have gotten done if this had been the rule in effect at the time!
We hope SBA will reconsider their approach on this type of lending, especially during this difficult economic period. Times continue to change and lenders should be prepared to adjust accordingly. We are here to help through training, coaching and consultation when writing (or rewriting) SBA policies and procedures.
Take the Right Approach!
Karen McHugh and Brian Burke
