In states with liquor license quotas, the market value of a liquor license can significantly exceed the operating cash flow of the business holding it, creating a valuation challenge for SBA 7(a) loans. These loans prioritize the business as a going concern, focusing on cash flow rather than intangible asset premiums, often leading to a mismatch between appraised value and purchase price. This paper explores the dynamics of liquor license quotas, their impact on business valuations, and strategies for lenders, buyers, and valuation professionals to address financing gaps.

Liquor License Quotas: An Overview

Liquor license quotas are regulatory caps on the number of licenses issued within a jurisdiction, typically tied to population metrics (e.g., one license per 3,000 residents). States such as Arizona, Florida, New Jersey, and Pennsylvania enforce these limits, creating scarcity that drives a secondary market for licenses. In high-demand areas, such as urban New Jersey or coastal Florida, licenses can command prices from $250,000 to over $1 million, far exceeding their nominal issuance fees.

This market dynamic stems from supply constraints and demand for alcohol-serving businesses, particularly in restaurants and bars. Quotas aim to control alcohol distribution and mitigate social harms, but they inadvertently inflate license values, impacting business transactions and financing. The secondary market operates through private sales, auctions, or state lotteries, with processes varying by state.

SBA 7(a) Loan Valuation Principles

The SBA 7(a) loan program supports small business acquisitions but imposes strict valuation guidelines. Valuations must focus on the business as a going concern, emphasizing cash flow generated by operations. A qualified appraiser is required for loans exceeding $250,000 or when a close relationship exists between buyer and seller.

This approach aligns with the SBA’s goal of ensuring loan repayment through business performance, not speculative asset values. However, it creates challenges in quota states, where liquor licenses often represent a significant portion of a business’s purchase price.

The Valuation Disconnect: Analysis and Implications

Understanding the Disconnect

In quota states, the market value of a liquor license can dwarf the cash flow of the business holding it. For example, a New Jersey restaurant with annual cash flow of $100,000 may include a liquor license valued at $750,000 on the secondary market. An SBA 7(a) appraisal, focusing on cash flow and a risk adjusted capitalization rate, might value the business at $300,000–$350,000, excluding the license premium. This disconnect complicates loan approvals, as lenders are restricted to financing the appraised value.

Broader Implications

The valuation disconnect has ripple effects across the lending ecosystem:

Lenders: Face pressure to adhere to SBA guidelines while managing borrower expectations. Loans may be denied or reduced if the purchase price significantly exceeds the appraised value.

Buyers: Risk overpaying for businesses or facing liquidity constraints, as license premiums require substantial upfront capital.

Sellers: May struggle to attract buyers willing to finance the license premium outside SBA loans, potentially lowering sale prices.

Valuation Professionals: Must navigate conflicting priorities, balancing market realities with SBA compliance.

Strategies for Stakeholders

For Valuation Professionals

Transparent Methodology: Clearly document the cash flow-based approach, noting the exclusion of separate license valuations.

Market Context: Include a qualitative discussion of the liquor license’s market value, if available, to inform lenders and buyers, even if it’s not factored into the appraisal.

For Lenders

Proactive Communication: Educate borrowers about the SBA’s valuation focus early in the process to set realistic expectations for loan amounts.

Flexible Structuring: Explore loan structures that combine SBA financing with other sources (e.g., mezzanine debt) to address financing gaps.

For Buyers

Due Diligence: Assess the liquor license’s market value independently, using data from state liquor boards or brokers, to negotiate purchase prices.

Financing Options: Consider alternatives to bridge valuation gaps, such as:

• Seller Financing: Negotiate deferred payments with the seller to cover the license premium.
• Private Lenders: Secure short-term loans from non-SBA lenders, though at higher interest rates.
• Equity Partners: Bring in investors to provide capital for the license portion of the purchase.

Conclusion

Liquor license quotas create a unique challenge for SBA 7(a) lending, as their market-driven premiums clash with cash flow-based appraisals. This disconnect complicates financing for buyers, lenders, and sellers in quota states. By understanding the valuation principles and leveraging creative financing, stakeholders can navigate these challenges effectively.

States with Liquor License Quotas and Their Systems

Liquor license quotas limit the number of licenses issued, often based on population ratios, creating secondary markets with significant premiums. Below is an updated list of states with quota systems, verified against primary and industry sources.

1. Alaska: Limits licenses based on population; transferable with approval from the Alcohol and Marijuana Control Office.
2. Arizona: Uses a population-based quota with a lottery for new licenses; existing licenses are sold privately.
3. California: Caps on-sale general licenses by county population; existing licenses purchased if new ones unavailable.
4. Florida: Quota tied to county population; new licenses via lottery.
5. Idaho: Limits licenses by city population; resale banned since 2023 to curb costs.
6. Kentucky: County-specific quotas; applicants consult local ABC offices.
7. Massachusetts: Municipal quotas based on population; additional licenses require legislative approval.
8. Michigan: On-premise license quotas by municipality population; existing licenses purchased if unavailable.
9. Minnesota: Municipalities set quotas; varies by city/county.
10. Montana: Quotas by city/town population; licenses acquired via purchase or lottery.
11. New Jersey: Retail consumption licenses limited by municipal population; secondary market prices often exceed $500,000.
12. New Mexico: Population-based quotas; licenses transferable with state/local approval.
13. Ohio: Quotas by municipality population; consult Ohio Department of Commerce.
14. Pennsylvania: County-based retail license quotas; transferable within county, with auctions for expired licenses.
15. South Dakota: City population-based quotas; new licenses via lotteries or auctions.
16. Utah: Bar license quotas by population; waiting list for unavailable licenses.
17. Wisconsin: “Class B” license quotas by municipality; exceptions possible.
18. Wyoming: Retail license quotas by city/town population; apply through local authorities.