When you’re looking for business financing to buy a business, it’s important to know what goes into the purchase price. While a business’s goodwill (branding, market position, customer lists, and more) often makes up a significant portion of the price, it’s not the only item that comes into play.
Goodwill can’t be used as collateral, so the business and equipment appraisals performed by your lender during the purchase process are also important.
Learn more about how businesses are valued for sale, and how equipment appraisals can impact the price when buying a business with an SBA 7(a) loan.
Getting started with business acquisition: purchase price and appraised value
When you buy an existing business, there are two important numbers to keep in mind: The purchase price of the business and its appraised value. The purchase price is negotiated between you and the seller. The appraised value is determined by an independent appraiser who is trained and qualified in making business valuations.
The SBA defines the purchase price as all assets being acquired, which includes tangible assets like real estate, machinery, inventory, and equipment, as well as goodwill. Keep in mind though, that commercial real estate that’s included as part of a business acquisition has its own appraisal and collateral requirements.
When will your lender require a third-party business valuation?
The SBA requires a third-party business valuation if the 7(a) loan amount is greater than $250,000 or if there’s a close relationship between you and the seller (such as family members, for example). Your lender may also require it regardless of the amount being financed or the relationship between yourself and the seller.
It’s important to keep in mind that a business valuation can include an adjusted net book value for the equipment to be acquired. This would meet SBA requirements if the total valuation (including intangible assets) meets or exceeds the purchase price. If the valuation is below that, you may need to renegotiate the price with the seller.
Also, if your lender or the SBA does require a business valuation or equipment appraisal to be prepared by a third party, this is typically paid by you before ordering the valuation or appraisal. However, these fees can be counted toward your owner-equity requirement.
When is an equipment appraisal recommended as part of the business valuation?
There are certain scenarios where it could be helpful to obtain a separate equipment appraisal. This can happen when the business you’re buying relies heavily on its equipment to continue running (for example, a machine shop). Your lender may also request or require an equipment appraisal separate from the business valuation depending on the transaction or the lender’s own policies.
It’s important for business valuations to consider whether the business is truly sustainable. A separate equipment appraisal can help answer these questions and fill any information gaps you may have before you buy the business.
How can an equipment appraisal impact a business valuation?
The best way to see the impact of an equipment appraisal on a business valuation is to look at an example.
Let’s say a machine shop is for sale for $500,000. The purchase agreement you’ve negotiated with the seller includes the business’s inventory, equipment, and goodwill. A third-party business valuation indicates a total business value of $550,000, which exceeds the purchase price of $500,000.
Scenario 1: Your lender only requires a third-party business valuation and not a separate equipment appraisal. On-hand inventory is valued at $25,000 and the net book value of the equipment is $150,000. To estimate the value of intangible assets, the appraiser subtracts the inventory and the net book value of the equipment from the total business value ($550,000 ‐ $25,000 – $150,000), which is $375,000. In this case, the total for intangible assets (goodwill) is high compared to its tangible assets (inventory and fixed assets).
| Final business value | $550,000 |
| Cash or cash equivalent | $0 |
| Accounts receivable | $0 |
| Inventory | $25,000 |
| Other current assets | $0 |
| Fixed assets (net book value) | $150,000 |
| Total tangible assets | $175,000 |
| Current liabilities | $0 |
| Long-term liabilities | $0 |
| Total liabilities included in value | $0 |
| Assets less liabilities | $175,000 |
| Total intangible assets included in value | $375,000 |
Scenario 2: Your lender requires a third-party business valuation and a separate equipment appraisal. The on-hand inventory is valued at $25,000 and the appraised value of the equipment is $350,000. To estimate the value of intangible assets, the appraiser subtracts the inventory and the appraised value of the equipment from the total business value ($550,000 ‐ $25,000 – $350,000), which is $175,000.
In this case, the equipment appraisal gives your lender the most accurate value for the business’s tangible assets. This improves their confidence in the quality of the equipment being purchased and allows them to use a higher amount to determine the collateral value for the loan. You’ll also see that the value of the business’s goodwill is much lower when you include the appraised value of the equipment.
| Final business value | $550,000 |
| Cash or cash equivalent | $0 |
| Accounts receivable | $0 |
| Inventory | $25,000 |
| Other current assets | $0 |
| Fixed assets (appraised value) | $350,000 |
| Other assets | $0 |
| Total tangible assets | $375,000 |
| Current liabilities | $0 |
| Long-term liabilities | $0 |
| Total liabilities included in value | $0 |
| Assets less liabilities | $375,000 |
| Total intangible assets included in value | $175,000 |
An overview of the business valuation and equipment appraisal process
Here’s a breakdown of the process when there’s no real estate involved, and the purchase price of the business only includes goodwill and tangible assets:
- Your lender will review your purchase agreement and determine the level of valuation that’s necessary. This includes whether a separate equipment appraisal is recommended or required by your lender.
- As a general rule for SBA 7(a) loans, if the loan amount is over $250,000 or there’s a close relationship between you and the seller, your lender must require a third-party business valuation. If the amount to be financed is below $250,000 and there’s no close relationship, then the decision will be based on your lender’s policy for similarly sized non-SBA loans.
- Your lender will have a list of qualified third-party sources and let you know what the cost of the appraisals are. If you’re required to pay before ordering the reports, then this cost can count towards your owner-equity contribution.
- If there’s a shortfall in either the business valuation or the equipment appraisal, you’ll need to renegotiate with the seller. The SBA 7(a) loan program can’t finance anything greater than either the purchase price or the appraised value of the business.
Pursuit is here to help
Whether you’re looking to start or expand your business, Pursuit is here to support your success every step of the way. With 15+ loan options, we can help you find the funding that fits your needs. Reach out to us today to and see how we can help your business grow.
