Understanding Global Cash Flow in SBA 7(a) Loan Underwriting vs. Free Cash Flow in Business Valuations

~ Certified Business Appraiser

SBA 7(a) loan underwriting relies on global cash flow (GCF) to assess the collective repayment ability of borrowers and guarantors, while business valuations for SBA 7(a) acquisition loans focus on free cash flow (FCF) to determine a business’s stand-alone value. This white paper clarifies the distinctions, purposes, and reasons GCF cannot justify higher valuations, emphasizing the capitalization of earnings method for robust SBA 7(a) valuations.

Introduction to Global Cash Flow in SBA Underwriting

SBA 7(a) underwriting requires lenders to evaluate repayment ability for both the borrowing entity and guarantors, particularly when the business alone lacks sufficient cash flow. Global cash flow consolidates:

  • Cash flow from the borrowing business.
  • Personal income of guarantors.
  • Cash flow from other guarantor-owned businesses.
  • All related debt service obligations.

GCF’s purpose is credit risk mitigation, ensuring the broader financial picture supports the loan when the primary business is weak.

Global Cash Flow: A Risk-Based Underwriting Tool

Lenders calculate the Global Debt Service Coverage Ratio (Global DSCR): Global DSCR = Total Global Cash Flow / Total Global Debt Service Obligations

A DSCR of 1.15x or higher is typically required, ensuring at least 15% excess cash to service all debts, providing a buffer against income disruptions.

Free Cash Flow in Business Valuation for SBA 7(a) Acquisitions

Business valuations for SBA 7(a) acquisitions focus on the stand-alone earning capacity of the target business, using free cash flow (FCF) available to a hypothetical buyer after:

  • Operating expenses.
  • Capital expenditures (CapEx).
  • Working capital needs.
  • Taxes.

The capitalization of earnings method estimates value based on sustainable FCF, excluding external income to reflect the business’s inherent worth.

Why Global Cash Flow Cannot Justify a Higher Valuation

A misconception exists that strong guarantor income increases a business’s value. This is incorrect under market-based valuation standards:

  • Business-Only Risk: Valuations reflect the business’s open-market worth, independent of the buyer’s finances.
  • Buyer-Specific Income: The SBA mandates valuations based on a hypothetical, financially capable buyer, not the actual buyer’s income.
  • Loan Approval vs. Valuation: Strong GCF may support loan approval, but the purchase price must be justified by the business’s FCF-based value.

Conclusion

Global cash flow assesses total repayment ability for SBA 7(a) underwriting, while free cash flow determines a business’s stand-alone value for valuations. The capitalization of earnings method, using FCF, ensures accurate SBA 7(a) valuations, unaffected by GCF. Understanding this distinction prevents inflated valuations, incorrect pricing, and failed transactions, supporting prudent lending and fair market deals.