The Bankability Method
Ensuring SBA 7(a) Financing Success to Close a Small Business Sale
The bankability method is an approach the author has developed using the income method of valuation, primarily for companies valued at $5 million and below, to assess the business can be financed under SBA 7(a) and sold. In the articles, the author describes the method and reasons for it being used.
The bankability method is an approach I use under the income method of valuation, primarily for companies valued at $5 million and below. These businesses are typically sold to individual buyers—often solo entrepreneurs—who rely on bank financing, most commonly through SBA 7(a) loans. Because of this, valuation must align with what a bank will finance.
At its core, the bankability method is based on three key criteria:
- The buyer must earn a reasonable salary;
- The business must be able to repay the acquisition debt within approximately five years; and
- The deal must maintain a debt service coverage ratio (DSCR) between 1.5 and 1.75.
This assumes a typical SBA structure with a 10% down payment.
Why Bankability Matters
In my experience, if a deal does not meet these thresholds, it is unlikely to close. Early in my career, when evaluating acquisitions for myself, my primary trigger was simple:
If the business could pay for itself within five years from its cash flow, I moved forward.
While every transaction has nuances, bank financing ultimately dictates what is feasible. Banks “sell money,” and when deals are structured with 10-year amortizations and DSCRs as low as 1.25—without factoring in a reasonable owner salary—it creates excessive leverage and increases the likelihood of failure.
The Problem with Overvaluation
One of the biggest issues I see in the market is overvaluation. In many cases, a seller receives an inflated valuation, becomes anchored to that number, and the business never sells because the deal is no longer bankable.
A real example: A partner and I valued a company at $8 million. There was a willing and capable buyer—a key employee—ready to proceed. The seller sought another opinion, and a second valuation came in at $15 million. The seller fixated on that number. The buyer could not secure financing at that level, and the deal fell apart. The business ultimately never sold.
Unfortunately, I have spoken with valuation professionals who admit they inflated values simply because “the owner wanted to sell.” This does a disservice to the client by creating unrealistic expectations and reducing the probability of a successful transaction.
Understanding “True Cash”
A critical concept in the bankability method is what I call “true cash.” While EBITDA is a useful metric, it does not account for principal debt payments, which are balance sheet items—not reflected on the income statement. In leveraged transactions, especially those structured with long amortizations and thin DSCRs, principal payments can significantly erode actual cash flow. The result? A business that appears profitable on paper may, yet, in reality, it may generate little—or even negative—cash flow.
I have seen this repeatedly:
- A business earning $80,000 over six months had no cash in the bank due to equivalent debt principal payments
- Another company reported $1 million in profit but had negative $400,000 in true cash due to heavy leverage
Most business owners do not fully understand this dynamic, and it is a critical risk factor.
Strategic vs. Financial Buyers
Valuation also depends on the type of buyer. Financial buyers—especially those relying on bank financing—must base their decisions on current cash flow and bankability.
Strategic buyers, however, may evaluate a business based on how it performs under their ownership. In some cases, I have personally paid above “bankable value” to eliminate a competitor or gain market share. While this may not align with strict financial metrics, it can make strategic sense.
Similarly, large acquirers often evaluate deals based on post-acquisition performance. In one case, a $10 billion company indicated their acquisition threshold was a 33% return; based on how the business would perform under their control, not its standalone results.
Final Thoughts
Valuation is not an exact science—it is an art. While formulas and methodologies are important, real-world outcomes depend on financing realities, buyer behavior, and market dynamics. The bankability method is designed to bridge the gap between theoretical value and executable transactions—helping ensure that businesses not only look good on paper but sell.
Terry Lammers, CVA, has spent 20 years building and growing Innovative Business Advisors, completing 11 acquisitions along the way. Prior to co-founding Innovative Business Advisors with his partner, Steve Denny, he worked as a commercial banker. Mr. Lammers has also served as CFO for a company he helped grow from $9 million to $80 million in revenue over six years. He is the author of You Don’t Know What You Don’t Know: Everything You Need to Know to Buy or Sell a Business.
Mr. Lammers may be contacted at (800) 767-2465 or by e-mail to terry@innovativeba.com.
