Business valuations play a pivotal role in underwriting SBA 7(a) loans, especially for business acquisitions. However, many lenders misunderstand key principles underlying valuation methodology, potentially leading to flawed underwriting, non-compliance with SBA SOP requirements, or exposure to guaranty denial risk. This white paper outlines the ten most common misunderstandings SBA lenders have about business valuations and provides clarifications grounded in best practices and regulatory guidance.

1. Enterprise Value vs. Equity Value

Many lenders mistakenly treat enterprise value and equity value as interchangeable. Enterprise value represents the value of the entire business operation, irrespective of its capital structure. In contrast, equity value reflects the residual value available to shareholders after subtracting debt and adding excess assets. In SBA transactions, confusion between these figures can lead to over- or under-financing.

Clarification: SBA business valuations should clearly distinguish between the value of the operating entity (enterprise value) and the net value to be transferred to the buyer (equity value).

2. The Role of Normalization Adjustments

Lenders often take financial statements or tax returns at face value without understanding that valuation professionals adjust these figures to reflect the true economic earnings of the business. These adjustments—called normalization or recasting adjustments—remove owner-specific, non-recurring, or discretionary expenses to better reflect the business’s maintainable cash flow.

Clarification: Normalization ensures comparability and provides a realistic view of free cash flow from a market participant perspective.

3. Fair Market Value Is Not the Asking Price

Some lenders expect a valuation to justify the seller’s asking price. However, fair market value is based on what a hypothetical buyer and seller would agree to, neither being under compulsion, and both having reasonable knowledge of the relevant facts.

Clarification: SBA requires valuations to reflect fair market value—not strategic value or asking price.

4. You Can’t Include Unreported Cash

Lenders may encounter sellers who claim to have unreported cash sales and ask why those amounts weren’t added back in the valuation. However, doing so would imply acceptance of tax fraud and would undermine the credibility of the valuation.

Clarification: Valuations must be based on verifiable financials, typically tax returns. Unreported cash cannot be reliably or legally incorporated.

5. Projections and Annualized Financials Are Unreliable

Lenders sometimes rely on partial-year financials or projections to support the deal value. However, the SBA requires valuation professionals to base conclusions on historical data that aligns with IRS tax return transcripts.

Clarification: Use of projections is risky and typically not compliant with SBA SOP unless properly supported by detailed plans and reconciled with historical performance.

6. Goodwill Isn’t the Whole Business

Some lenders misunderstand goodwill as synonymous with business value. In fact, goodwill is the residual intangible value after subtracting the fair market value of tangible assets from the total enterprise value.

Clarification: SBA requires appraisers to segregate goodwill when determining the unsecured portion of a loan.

7. The Valuation Must Be Independent

Pressure to “hit the number” can compromise valuation integrity. SBA regulations require appraisals and valuations to be conducted independently, without undue influence from the lender or buyer.

Clarification: A valuation shaped to support a loan package may jeopardize SBA loan guaranty eligibility.

8. Free Cash Flow Drives Value—Not Multiples

Some lenders rely too heavily on generic EBITDA or SDE multiples, expecting these shortcuts to determine business value. However, multiples are context-dependent, derived from underlying cash flows, and sensitive to company-specific risks, size, and industry dynamics. Treating multiples as fixed benchmarks ignores the complexity of valuation.

Clarification: Free cash flow is the true driver of value in a business valuation. Multiples are not the method—they are simply a market shorthand derived from transactions where underlying cash flows were already understood. Relying on multiples alone, without assessing normalized free cash flow, undermines valuation credibility.

9. Valuations Are Not Appraisals of Collateral

A valuation of the business as a going concern is distinct from a collateral appraisal. Lenders sometimes treat the valuation as a tool to justify the loan amount or LTV ratio.

Clarification: Valuations assess economic value based on earnings, not liquidation value or asset coverage.

10. A Valuation Is Not the Same as Loan Feasibility

Some lenders assume that if a business appraises at or above the purchase price, the loan is sound. However, valuation is only one part of underwriting. Feasibility, cash flow, and repayment capacity must also be independently assessed.

Clarification: Valuation conclusions do not account for financing structure, debt service coverage, or buyer readiness.

Conclusion

Misunderstandings about business valuations can expose SBA lenders to compliance risks, faulty underwriting, and potential loan loss. Proper training and awareness of the valuation process and regulatory standards are essential to ensure SBA loans are supported by credible, independent, and well-documented valuations.