In the context of SBA 7(a) lending, the business valuation standard used in underwriting is more than a technicality—it affects the defensibility of the loan, regulatory compliance, and ultimately portfolio performance. This guide explains the critical distinction between Fair Market Value (FMV) and Strategic Value, and why SBA lenders must ensure that valuations adhere to the FMV standard. It also explores common pitfalls, the economic logic behind the standards, and a practical example using the capitalization of free cash flow method.

Why Valuation Standards Matter in SBA Lending

SBA requires that business valuations supporting loan underwriting be prepared under the Fair Market Value standard. Failure to apply this standard can lead to:
– Loan denials or SBA guaranty repairs
– Regulatory or audit concerns
– Inflated purchase prices unsupported by sustainable cash flow

Lenders should be alert to valuations that improperly reflect Strategic Value, which may artificially inflate a business’s worth based on buyer-specific assumptions or synergies.

Understanding the Standards

Fair Market Value (FMV)

FMV represents the price at which a business would sell in a hypothetical transaction between a willing buyer and willing seller, with neither under compulsion and both having reasonable knowledge of the relevant facts (IRS, 1959).

This standard assumes:
– A hypothetical buyer and seller
– Market-based motivations
– Neutral, third-party assumptions
– No buyer-specific synergies or advantages

Strategic Value (or Investment Value)

Strategic Value reflects the value of a business to a particular buyer, often including unique cost savings, revenue enhancements, or operational synergies. These factors are specific to the buyer’s circumstances and are not considered in FMV.

Strategic Value might include:
– Consolidation of overlapping functions
– Elimination of competition
– Access to proprietary assets or markets
– Tax or location-specific benefits

In SBA lending, Strategic Value is not appropriate for underwriting purposes.

Case Study: Capitalization of Free Cash Flow

Let’s examine a hypothetical company being acquired by an individual borrower with SBA 7(a) financing. This service-based business generates normalized free cash flow of $450,000 per year after adjusting for reasonable officer compensation.

A market-based risk-adjusted capitalization rate of 14% (or cap factor of 7.1) is determined, based on size, industry risk, and required rate of return.

Fair Market Value Calculation:

FMV = Free Cash Flow / Capitalization Rate = 450,000 / 0.14 = 3,214,000

Strategic Value Comparison:

Now suppose a regional competitor sees an opportunity to consolidate back-office functions, saving an additional $200,000 per year. Their buyer-specific free cash flow becomes: 450,000 + 200,000 = 650,000

Strategic Value = 650,000 / 0.14 = 4,643,000

This $1.4 million premium reflects strategic synergies—value real only to that buyer—not the FMV standard SBA requires.

Why SBA Lenders Must Insist on FMV

The SBA requires FMV to ensure:
– Purchases are supported by the business’s standalone cash flow
– Borrowers are not overleveraged by speculative future benefits
– Loan underwriting remains neutral and market-based

Strategic Value—no matter how compelling—introduces buyer bias into the valuation. While a buyer may be willing to pay more, SBA financing must be grounded in what a typical buyer would pay, not an outlier.

Common Red Flags for Lenders

– “Synergy” or “strategic buyer” language in selling memorandums or appraisal reports
– Premiums unexplained by financial performance
– Valuation methods relying on buyer-specific revenue projections
– Purchase prices materially above FMV indications

The distinction between Fair Market Value and Strategic Value is more than academic—it is essential for SBA 7(a) lending integrity. FMV supports safe, market-based lending decisions that protect lenders and borrowers alike. Strategic Value has a place in corporate acquisitions and investment negotiations, but not in SBA loan underwriting. When in doubt, lenders should seek clarification from appraisers and ensure the valuation aligns with SBA’s FMV standard and cash-flow-based logic.