SBA 7(a) and 504 Loans

How Business Valuations Drive Smarter Lending Decisions

This article provides a case study that highlights the methodology behind SBA-compliant business valuations. The article underscores the importance of grounding the analysis in standard valuation techniques, using reliable industry benchmarks, and properly documenting adjustments. The role and value of business appraisers to the lender and parties involved in a potential SBA-financed transaction is also discussed.

Business valuations play a vital role in SBA financing. For both 7(a) and 504 loan programs, an independent business valuation is typically required in the following situations:

• The total financing amount (including SBA loans, seller financing, or other funding sources) exceeds the appraised value of real estate and/or equipment by more than $250,000.
• There is a close relationship between the buyer and seller, indicating the transaction is not at arm’s length.
• The loan involves a change in ownership between existing partners in a business that has been in operation for more than one year.

To meet SBA requirements, the valuation must be conducted by a qualified, independent professional—someone not involved in the loan transaction—who has demonstrated expertise in business valuation and holds relevant credentials such as: Accredited Senior Appraiser (ASA), Certified Business Appraiser (CBA), Accredited in Business Valuation (ABV), Certified Valuation Analyst (CVA), or Accredited Valuation Analyst (AVA).

SBA 7(a) and 504 loans are powerful alternatives to traditional financing, offering a range of benefits that make them especially attractive to growth-minded business owners. Backed by the federal government, these programs typically require lower down payments; just 10–15%, compared to the 20–30% often needed for conventional loans. This helps business owners preserve valuable working capital for day-to-day operations. Borrowers also benefit from longer repayment terms—up to 25 years for real estate and 10 years for equipment—which translate to more affordable monthly payments and improved cash flow management. The 504 loan program offers below-market fixed interest rates, and both programs feature more flexible credit and collateral requirements, increasing access for startups and expanding businesses that may not qualify through traditional lenders.

SBA-financed business acquisitions offer structural flexibility, allowing buyers to pursue either an asset purchase or a stock purchase based on their goals and the nature of the business being acquired. Each approach has distinct implications and requires different financial adjustments.

In an asset purchase, the buyer acquires selected business assets—such as equipment, inventory, customer lists, and intellectual property—without taking on the legal entity itself. This structure is generally favored by SBA lenders, as it limits exposure to unknown or contingent liabilities. Buyers also benefit from tax advantages, including a stepped-up basis in depreciable assets, which can lead to meaningful tax savings over time.

Alternatively, an SBA loan can be used to finance a stock purchase, where the buyer acquires ownership interests (e.g., stock, membership units, or partnership shares) in the existing legal entity. This structure is often necessary when the business holds non-transferable licenses, permits, or contracts that would be difficult to assign in an asset sale. However, stock purchases typically carry greater risk, as the buyer assumes all of the company’s liabilities; both known and unknown.

From a lending perspective, a knowledgeable SBA advisor can provide strategic guidance on structuring the transaction; whether that involves incorporating seller financing, waiving a down payment for business expansion, or exploring creative financing solutions. However, it is important to note that each lender has its own policies and preferences.

For example, Keyur Patel, VP and Senior SBA Loan Officer at DFCU Financial, explains:

“The SBA offers multiple loan options, most notably the SBA 504 and 7(a) programs. Many lenders don’t offer both options simultaneously when a borrower is purchasing a business along with owner-occupied real estate, but DFCU does. We’ve structured many transactions by splitting them between the two programs, because the associated costs can vary. In many cases, using the 504 loan for the real estate component results in more favorable rates compared to doing the entire deal through 7(a).”

“If the business has strong enough cash flow to service the combined debt and the borrower has other assets—like equity in a primary residence—that can help cover any collateral shortfall on the business acquisition side, a split structure can be advantageous. For instance, we recently financed a daycare acquisition involving both the business and the real estate. The borrower had sufficient funds to cover the minimum 10% down payment on the SBA 504 loan for the real estate, and significant home equity to secure the 7(a) portion for the business acquisition. This structure allowed the borrower to benefit from a lower rate and longer 25-year amortization on the real estate, while financing the goodwill and business assets on a shorter 10-year term under the 7(a) program. In the end, the split structure lowered the overall cost and provided sufficient collateral for the lender.”

From a business valuation standpoint, income and market approaches are commonly used to value operating businesses in SBA-financed transactions. Under the market approach, appraisers typically rely on the merged and acquired company method. The income approach typically involves the discounted cash flow (DCF) method or the capitalization of earnings method. In certain cases, the excess earnings method—a hybrid of asset and income approaches—may also be applied.

However, it is important to exercise caution with the DCF method, particularly in asset purchase scenarios where a new legal entity is being formed. Relying heavily on forward-looking projections in such cases may introduce speculative risk, as the projections relate to a newly created entity rather than the historical performance of the original business.

That said, as confirmed in a recent discussion with an SBA team representative, the final decision on valuation methodology rests with the lender’s discretion. Lenders evaluate the valuation’s relevance and reliability in context with the deal structure, borrower qualifications, and risk profile.

To conduct a business valuation for SBA financing, we typically require three years of business tax returns, the year-to-date profit and loss statement and balance sheet, as well as a copy of the letter of intent (LOI). If available, reviewing the bank’s credit memo can also provide valuable context.

As part of the valuation process, we carefully analyze the company’s historical tax returns and apply normalization adjustments where appropriate; removing discretionary, one-time, or personal expenses to reflect the true economic earnings of the business.

One key area of focus is rental expense, particularly when the current business owner also owns the underlying real estate. In such cases, we ensure that the financials reflect a market-based or lease-based rental expense consistent with what the new owner would pay going forward. This may involve referencing a negotiated lease agreement or comparing market rental listings for similar properties based on location, square footage, zoning, and usage.

A helpful sanity check involves benchmarking the rental expense against the capitalization rate (cap rate) for the real estate. By dividing the rental expense by a reasonable cap rate, we can estimate the implied property value. If this figure appears significantly over- or understated relative to market norms, the rental expense may need to be adjusted to reflect real-world economic values, not hypothetical ones.

Additionally, we assess the current owner’s compensation and adjust as needed based on the anticipated role and responsibilities of the new owner. This ensures the valuation accurately reflects the operational and financial reality the buyer will assume post-acquisition.

Let’s consider a real-world example involving the valuation of a landscaping business in Florida to illustrate how SBA financing transactions are underpinned by careful analysis and professional judgment.

The company provided four years of financial statements, revealing steady revenue growth—despite a COVID-19-related dip in 2021—with top-line numbers increasing from $1.0 million in 2020 to $1.5 million in 2023.

Gross profit margins remained strong, averaging in the mid-40% range, while net income demonstrated solid profitability in three of the four years. EBITDA peaked in 2022 and remained consistent into 2023 at approximately $290,000.

Upon reviewing the financials, several normalization adjustments were made to reflect the earnings power of the business. Non-recurring items such as bad debt and reimbursement expenses were removed, and discretionary expenses like charitable contributions and guard dog costs were excluded. Owner compensation was normalized using ZipRecruiter’s salary data for Florida landscape business owners, adjusted annually by 3.5% for inflation. Similarly, rental expenses were adjusted to reflect the new owner’s expected lease terms, and other non-operating items such as depletion expense and Section 179 deductions were removed.

The resulting normalized EBITDA across four years was averaged at $246,000 (rounded). We projected depreciation at 3.3% of revenue and assumed it would offset ongoing capital expenditures. Working capital needs were estimated at 8.9% of incremental revenue growth, based on industry data from IBISWorld. These adjustments led to an estimated sustainable, distributable cash flow of $150,000 (rounded). Using a 15% capitalization rate, the indicated fair market value of total invested capital was $1.0 million (rounded). After deducting $51,000 (rounded) of interest-bearing debt, the company’s equity value on a controlling, marketable basis was $981,000 (rounded). However, not all operating assets and liabilities were included in the transaction, so further adjustments were made: $62,000 (rounded) in liabilities not included in the sale were added back, while $260,000 (rounded) in operating cash and $76,000 (rounded) in accounts receivable were deducted, resulting in an adjusted value of $708,000 (rounded). Given that the equity value was calculated on a marketable basis, a 4.0% discount for lack of marketability (DLOM) was applied using the Chaffe synthetic put option model, producing a final indicated fair market value on a controlling, non-marketable basis of $680,000 (rounded).

To corroborate the income-based conclusion, we also applied a market approach using recent transactions from the DealStats and PeerComps databases. Relevant financial comparables in the landscaping industry, structured as asset purchases, showed multiples ranging from 0.51x to 0.71x revenue, 2.12x to 2.69x seller’s discretionary earnings (SDE), and 3.42x to 3.5x EBITDA. A correlation analysis confirmed a meaningful relationship between transaction prices and financial performance metrics. We applied a blended approach, assigning 50% weight to the income approach and dividing the remaining 50% between the two market data sources. This produced an overall indicated fair market value of business assets at $853,000. Based on the fixed assets balance of $237,000, the remainder of the value was allocated to goodwill (the business had no inventory).

This case study highlights the methodology behind SBA-compliant business valuations. By grounding the analysis in standard valuation techniques, reliable industry benchmarks, and well-documented adjustments, business appraisers provide a critical foundation for lender confidence. At the same time, this process empowers entrepreneurs to acquire businesses with clarity, structure, and confidence; positioning them not only to operate effectively but to grow and thrive in the years ahead.

---

Nataliya Kalava, CVA, ABV, MAFF, CMEA, is an expert in the fields of business valuation and finance, with about 15 years of experience. She has led and contributed to numerous valuations for diverse purposes, including gift and estate tax planning, management planning, M&A transactions, SBA valuations, financial reporting, and litigation support. Ms. Kalava’s passion lies in helping business owners navigate ownership transitions, guiding them through challenges, and uncovering opportunities for growth. Her expertise is honed through a rich career journey, having worked with renowned organizations such as Equinix Inc., Humana Inc., BDO LLP, Sigma Valuation Consulting Inc., and PwC. Ms. Kalava’s dedication to her profession extends to education and community engagement. She has been an Adjunct Finance faculty member at the University of Tampa, imparting her knowledge to undergraduate students on corporate finance and investment. Furthermore, she organizes Continuing Legal Education (CLE) courses on business valuation topics accredited by the Florida Bar.

Ms. Kalava can be contacted at (813) 777-9706 or by e-mail to nkalava@one10firm.com.