Small Business Administration SOP 50-10 5 (C)
and Small Business Jobs and Credit Act

Small Business Administration SOP 50-10 5 (C) and
Small Business Jobs and Credit Act
October, 2010 Update

Submitted by Scott Gabehart, CBA

In the aftermath of the recent flurry of regulatory and legislative changes which impact various SBA loan programs that are in turn a source of business for many IBA members (appraisers and brokers alike), the time seemed right for an update which summarizes the recent alterations to the SBA’s 7(a) and 504 programs AND the new law which seeks to promote small business and creates a large $30 billion community fund for the nation’s smaller lenders. Both the SOP changes and the changes put forth through the Small Business Jobs Creation Act of 2010 will impact the demand for and the provision of BV and brokerage services.

The past four years have seen a wave of unprecedented change within the SBA and its loan programs, with James W. Hammersley, Deputy Assistant Administrator for Policy and Strategic Planning at the SBA guiding and overseeing the changes through two diametrically opposed administrations and the worst recession in as many as 30 years or longer. With no revisions to the SOP occurring between 2000 and 2007, there have now been FOUR (4) substantial revisions to this hefty document since August of 2008 culminating in the new SOP 50-10 5 (C) version. The revised SOP may be found at http://www.sba.gov/aboutsba/sbaprograms/elending/reg/index.html.

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SBA Regulations Create Additional Demand for CBA's

The SBA has been under close scrutiny of the Congress of late, with rising default and charge-off rates involving both real estate and business loans likely to intensify their oversight. The "housing meltdown” and "mortgage crisis” are now household words and part of the American psyche, but relatively little is known about the SBA’s role in assisting small business owners obtain "guaranteed” financing from banks and other financial institutions. Even within the realm of professional business appraisal, the work opportunities which are available are often misunderstood and even belittled as being low-pay work that is unworthy of our time.

As a former business broker and current CBA, I have been involved with SBA-related acquisition financing for more than 15 years now. The benefits to buyers and sellers from using SBA-guaranteed financing are many, with the costs largely falling on the shoulders of taxpayers and to a lesser extent the buyer/borrowers. In short, the SBA’s 7(a) program allows buyers to acquire a going concern with as little as 10% cash down while providing the seller with as much as 90% cash at closing. Other benefits include an extended repayment term (10 years for business loans and longer for "blended” business and real estate loans), below market financing (less than seller financing rates) and improved marketability for business owners interested in selling.

After a long and often contentious exposure period and a subsequent revision, a new set of SBA regulations will take effect which greatly expand the opportunities for business appraisers to participate in this growth market. I am proud to say that I had the privilege to participate in the "give and take” which culminated in the "revised” regulations which will provide the lender, borrower and taxpayer with improved quality of appraisal work. The primary set of SBA regulations related to their loan programs are found in the so-called "SOP50-10(5)”, which covers 7(a) and 504 loan processing as well as the requirements to become and remain a 7(a) lender or a Certified Development Company (CDC). Included in this 400 page plus document are several paragraphs which address the role played by business valuation and business appraisers.

This SOP (standard operating procedure) was completely re-written and, on March 20, 2008, SOP 50 10(5) was made available with a delayed effective date. The purpose of the revision was to develop a more concise version of the SOP that is up to date and user-friendly. During the months of April, May and June, Agency staff received and reviewed questions and comments from program participants, including Lenders, CDC's, representatives of various trade associations, SBA personnel and concerned business appraisers (such as myself). As a result of this feedback, SBA has made what they refer to as "technical corrections” to clarify the SOP and has moved back the effective date. One of these "technical corrections” is extremely important from the point of view of business appraisers (as discussed next

Among the many changes found in the revised SOP, there are ultimately two pivotal changes which impact business appraisers and the amount of such work which will be available as of August 1st, 2008. In summary, these two changes are as follows:

1) Beginning 8-1-08, every SBA-guaranteed business acquisition loan over $350,000 MUST be supported by an independent appraisal performed by a "qualified source”.

2) A "qualified” party is now, for the first time ever (this was one of the "technical” corrections), a person who regularly receives compensation for business valuations AND who is accredited by a recognized organization (which naturally includes the Institute of Business Appraisers).

The fact is that prior to these changes, the individuals and companies performing such appraisals were not always certified and the specific cases which required "independent” appraisals were extremely limited, e.g. the subject business is being bought and sold by related parties or the business was already subject to a current SBA loan taken out within the previous 3 years. Although certain lenders sought to take the high road and hired only credentialed appraisers and requested appraisals even when they were not formally required, it is safe to say that the majority of lenders sought the lowest cost alternatives in most instances.

How big will the new market for SBA-related business appraisals be? Consider this – The total number of loans disbursed for approvals between October 1, 2000 and September 30, 2007 was approximately 500,000. With the number of loans generally rising from year to year (with the recent exception of 2008, as the economy softens and lenders tighten their standards across the board), it is likely that the next seven years will see a significantly higher number of loans.

Assuming an average of 100,000 loans per year for the next 7 years, this amounts to approximately 8,333 per month. It is not known how many of these loans were over $350,000, but it is likely that at least 33% of these loans were equal to or greater than this threshold. Therefore, it is not unreasonable to assume that there will be a demand for around 3,000 appraisals each month beginning August 1st, 2008. These are only rough approximations, but they serve to demonstrate the potential significance of these upcoming changes

Having personally performed close to 200 such appraisals in recent years, I am intimately familiar with the appraisal requirements, typical workload, stress levels, turnaround times and, of course, fee levels. It is true that the average price paid for SBA appraisals is lower than that paid for the typical estate tax appraisal, divorce appraisal, ESOP appraisal and any litigation-related appraisal work. It is also true that the work environment is much more pleasant and positive and generally less demanding. Another benefit is the potential stability of such work. If an appraiser performs as expected, lenders normally prefer to work with the same individuals who have proven their reliability and a steady stream of work is often the outcome.

1) In most cases, no site visit is required (it is not expected).

2) All of the parties involved are highly motivated (cooperative) to complete the appraisal in a timely manner, greatly reducing the "stress factor”. This includes the loan officer, underwriter, buyer/borrower, seller and business broker (if involved).

3) The contracts are normally (and should be) with the lender, and I have not worked with any lender who did not pay their invoices promptly (no risk of non-payment).

4) There is no time required for "haggling” over contract price, scope of work, turnaround time, etc., as most of these areas are fairly standardized on a lender by lender basis.

5) The work itself is rewarding in that the appraiser either helps a qualified individual purchase the business of their dreams or prevents them from making the mistake of a lifetime.

6) The work is also interesting in that the relevant standard of value is a type of quasi-fair market value due to the need to assess the repayment capability and probability in conjunction with the overall analysis. There are definitely "unique” valuation considerations when appraising going concerns within the SBA environment.

7) The businesses are not always "simplistic”, e.g. niche nanotechnology manufacturing company, global logistics and supply chain management firm, publisher of international newsletter for the rich and famous, etc.

8) There are "economies of scope and scale” which emerge from doing multiple SBA-related appraisals each month.

In short, there are many "mitigating” factors which help to overcome the relative fee differential. In exchange for a lower fee, the appraiser receives consistency, lower stress and rewarding and interesting assignments. In addition, there are some lenders who clearly recognize that "they get what they pay for” and they are willing to pay "above market” to obtain this help.

The upcoming change that will require the use of "qualified” appraisers (certified) should also help to stabilize the fee levels at a somewhat higher level. This is by no means guaranteed, however, as certain valuation firms may attempt to usurp a large piece of the market by offering below market fees and then streamlining their valuation process – potentially to the detriment of the lender, borrower, taxpayer and the SBA. It will be up to the lenders to prevent this from happening.

The following excerpts were taken from pages 178 and 179 of the new SOP and address the changes referred to earlier in this article. The SBA refers to business acquisition loans as "change of ownership loans”. (4) Change of Ownership – Additional Requirements When the loan will finance a change of ownership, a lender must meet additional requirements when the loan amount is more than $350,000 to ensure that the buyer is not paying more for the business than its cash flow can sustain. (i) Business Valuation Determining the value of a business (not including real estate which is separately valued through an appraisal) is the key component to the analysis of any loan application for a change of ownership. An accurate business valuation is required because the change in ownership will result in new debt unrelated to business operations and create "blue sky” or goodwill. A business valuation assists the lender and the buyer in making the determination that the seller’s asking price is supported by historic operations. (a) For loans of $350,000 or less, the lender may do its own valuation of the business being sold. (b) For loans greater than $350,000 or if there is a close relationship between the buyer and seller, the lender must obtain an independent business valuation from a qualified source. A "qualified source” is an individual who regularly receives compensation for business valuations and is accredited by a recognized organization. Some recognized organizations and the accreditations they provide include: 1. Accredited Senior Appraiser (ASA) accredited through the American Society of Appraisers; 2. Certified Business Appraiser (CBA) accredited through the Institute of Business Appraisers; 3. Accredited in Business Valuation (ABV) accredited through the American Institute of Certified Public Accountants; and 4. Certified Valuation Analyst (CVA) accredited through the National Association of Certified Valuation Analysts. (c) The lender may not use a business valuation provided by the seller or the buyer to meet these requirements.

Mr. Scott Gabehart is a CBA, author and former MBA faculty for The American Graduate School of International Management. He resides in Phoenix Arizona and can be reached at sgabe57806@aol.com or 602-692-0887.