SBA Valuation Considerations for Partial Change of Ownership Transactions

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2023 WithumSmith+Brown, PC
SBA Valuation Considerations for
Partial Change of Ownership
Transactions

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Presenters
Request a Quote
Brian McIntyre, CVA
Market Leader, Corporate Valuation and
SBA Loan Valuations
bmcintyre@withum.com
(856) 304 0455
Bryan DiMonte
Manager, Corporate Valuation and
SBA Loan Valuations
bdimonte@withum.com
(609) 429 5803

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 Founded in 1974
 National scale advisory and CPA firm
 Fully dedicated SBA business valuation group started in 2018
 Over 80 banks served
 Providing business valuations, machinery and equipment, and
commercial real estate appraisals
About Withum

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SOP 50 10 7 Update
• Effective August 1, 2023
• Allows loans for partial changes of ownership
• Selling owner is allowed to remain as an owner and involved in the day-to-day business, including
as an officer, director, Key Employee or Employee
• Expected to facilitate small business investments, expand access to ownership and increase
business succession options
• Reduced equity injection requirements
• Seller debt on standby can be considered equity injection
• Startups: No SBA requirements

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Impact on Valuations
The Benefits of Control
Applicable Discounts
Asset versus Stock Transactions
Case Study – Valuation Methods
Learning Objectives

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For Minority Interest Valuations…
• Minority value may be less than pro rata value of controlling interest (Discounts for Lack of Control
and Marketability)
• Normalization adjustments should not be universally applied (i.e. officer’s compensation)
• Cash flows available to a controlling owner may be greater than to minority owner
• Valuation methods may differ (i.e. asset approach possibly not applicable)
• Minority interest transactions will be structured as stock deals resulting in a need to understand the
balance sheet
• No readily available market for minority interests results in discount for lack of marketability
• Be aware of double counting in relation to valuation methods and assumptions versus discounts
applied (i.e. minority cash flows already result in minority value)

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Control Versus Minority
 Power to direct management, policies
and exit
 Generally greater than 50% of voting
interest
 Control of distributions during interim
period prior to exit event
 Readily available market to sell
 Level of value considered prior to SOP
50 10 7
Controlling Owner Minority Owner
 Subject to decisions made by
controlling ownership
 Generally less than 50% of voting
interest
 Cannot control exit event
 No guarantee of distributions prior to an
exit event
 No readily available market to sell
 Level of value which may now need to
be considered in SOP 50 10 7

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Levels of Control and Marketability
Strategic Control Value
Financial Control Value
Marketable, Minority Value
Non-marketable, Minority Value
Discount for Lack of
Marketability
Discount for Lack of
Control
Financial Control Premium
Strategic Control Premium
Where we end up

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Discount for Lack of Control
• The pro rata value of a controlling interest in a closely held company is said to be worth more than the value of a minority
interest because of the prerogatives of control that generally follow the controlling shares.
• An investor will generally pay more (a premium) for the rights that are part of the controlling interest
• Can be inferred through an income approach and supported through Mergerstat control premium data
• Prerogatives of Control:
• Elect the board of directors
• Appoint the management team
• Determine compensation and perquisites
• Set business policy
• Acquire or liquidate assets
• Make acquisitions or divestitures
• Sell or acquire treasury stock
• Register the stock for an IPO
• Declare dividends
• Change the articles of incorporation or bylaws of the corporation

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Discount for Lack of Marketability
• The DLOM reflects the impact on value of a security’s lack of liquidity or marketability. An interest that is not
registered with the SEC is not saleable on public security markets and is not readily convertible to cash.
Securities that lack the inherent liquidity of publicly traded securities may not be as attractive for investment
purposes.
• Studies include:
• Restricted Stock Studies
• Pre-IPO- The comparison of sales of closely held stock with their prices at the subsequent IPO
• Quantitative Methods
• Put option models (Chaffe/BSM/European, Finnerty/Average Asian Strike, others)
• Stout restricted stock studies
• Quantitative Marketability Discount Model (QMDM) – Mercer Capital
• Long-term Equity Anticipation securities (LEAPS)

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Discount for Lack of Marketability
Mandelbaum v Commissioner
• Mandelbaum v Commissioner - Tax court decision that provided guidance as to which factors to consider in
estimating a DLOM
• Factors include:
• Financial condition
• Dividend paying capacity
• Nature of entity and future outlook
• Depth of management
• Degree of control
• Restrictions on transfer
• Holding period
• Company’s redemption policy
• Costs associated with making a public offering

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Asset Versus Stock Transactions
 Majority of controlling transactions
 Generally only acquiring inventory and
fixed assets
 Cash and debt free
 Step up in basis and restart of
depreciation and amortization
Asset Transaction Stock Transaction
 Majority of noncontrolling transactions
 Will be the structure used in partial
ownership transactions for SBA
 Conclusion of value should consider
working capital deficits, institutional
debt, or shareholder debt

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Case Study: Landscaping Company
Case Study Facts
• The following are the hypothetical facts of a small business providing landscaping services
• Valuation Date: As of January 31, 2013
• Business Purchase: $100,000 for a 30% interest
• Transaction Type: C-Corp stock
• Intended Users: Although buyer has obtained a previous valuation, the lender has ordered a business valuation to comply
with internal policies, SBA Standard Operating Procedures and maintain independence.
• Officer’s Compensation: Company is paying officer $75,000 annually which is above market rate
• Real Estate: Company is paying above market rent at $50,000 annually on triple-net basis
• Next fiscal year expectations: Similar performance to 2022 based upon projections and management interview

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What Does the Report Tell Us?
What a Valuation Provides and Does Not Provide
• The findings in a business valuation may be limited by the following factors:
• Valuation Date: The valuation provides the fair market value of a company based upon one point in time considering information known
or knowable as of that date
• Fair Market Value: The valuation is conducted under the standard of fair market value. No buyer-specific synergies are considered
under fair market value
• Considers hypothetical buyer and seller
• Underlying Information: Data provided and relied upon to develop conclusions is assumed to be accurate
• Intended Users: SBA business valuations are prepared for the lender, not the buyer, seller, or any other party
• Transaction Type: An SBA business valuation is prepared under the legal structure of the proposed transaction as an asset or stock
deal.
• Partial ownership transactions will be structured as stock purchases

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The Tenets of Business Valuation
How Conclusions of Value are Supported
Methods
Assumptions
Inputs
• Asset
• Income
• Market
• Growth rates
• Profit margins
• Normalization adjustments
• Opportunities
• Risks
• Discount rates
• Multiples
• Weightings

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Valuation Approaches
Minority Ownership Considerations
Asset Income Market
• Guideline Transaction
Method
• Transactions represent
controlling purchases
• Capitalized Cash Flow
Method
• Discounted Cash Flow
Method
• Minority owner may not
realize “optimal” cash
flows
• Adjusted Net Asset
Method (book value)
• Minority owner cannot
realize value
• Factors into stock
transactions

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Asset Approach
When is it Applicable?
• The asset approach is generally helpful for:
• No goodwill exists: The business is not producing sufficient cash flow and the highest value is attributable to its tangible assets such as
real estate, machinery and equipment, or licenses.
• Combined with other approaches: When normalization adjustments are made to a business valuation the appraised value of real
estate may be considered non-operating
• Imminent Liquidation: The business plans to liquidate in the near future
• Floor Value: The value is traditionally considered a floor value for a going concern business. It helps corroborates results of other
approaches
• Capital Expenditures: The expected remaining useful life of tangible assets effects the reinvestment needs of the business. Businesses
with higher reinvestment needs have lower cash flows.
• For minority interests the asset approach is difficult to support in its use.

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Asset Approach
 Controls distribution of cash
 Controls repayment of shareholder
loans
 Can realize FMV of assets and liabilities
 Non-operating assets/liabilities
contribute to value (i.e. excess vacant
land)
Controlling Minority
 Cannot realize FMV of assets or
liabilities
 Cannot control amount or frequency of
distributions
 Cannot control repayment of
shareholder debt
 Non-operating assets/liabilities do not
influence immediate value (i.e. cannot
make use of vacant land)

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Asset Approach – Adjusted
Case Study
• Adjustments reflect standard of value
• Under a stock transaction all balance
sheet line items are included in the
valuation
• FMV of equipment not realizable by
minority shareholder as they cannot sell
assets
• FMV of shareholder loan reduced to fair
market interest rate
• Resulting FMV of $326,883 is on a
controlling basis
Adjusted Closing BS (01/31/2023)
Line Item (1) Book Value
Adjustments
to Book Value
Adjusted Book
Value
Fair Market
Value
Adjustments
Fair Market
Value
Assets
Cash 13,429 - 13,429 - 13,429
Accounts Receivable 37,542 - 37,542 - 37,542
Other Current Assets 5,374 - 5,374 - 5,374
Deposits 8,000 - 8,000 - 8,000
Total Current Assets 64,346 - 64,346 - 64,346
Property, Plant & Equipment, gross 87,043 - 87,043 250,457 337,500
less Accumulated Depreciation - - - - -
Property, Plant & Equipment 87,043 - 87,043 250,457 337,500
Total Long Term Assets 87,043 - 87,043 250,457 337,500
Total Assets 151,389 - 151,389 250,457 401,846
Liabilities & Equity
Accounts Payable 7,299 - 7,299 - 7,299
Current Portion of Debt 12,000 - 12,000 - 12,000
Credit Card Payable 30,664 - 30,664 - 30,664
Total Current Liabilities 49,963 - 49,963 - 49,963
Loan to Shareholder 35,000 - 35,000 (10,000) 25,000
Total Long Term Liabilities 35,000 - 35,000 (10,000) 25,000
Total Liabilities 84,963 - 84,963 (10,000) 74,963
Common Equity 66,426 - 66,426 260,457 326,883
Total Equity 66,426 - 66,426 260,457 326,883
Total Liabilities & Equity 151,389 - 151,389 250,457 401,846

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Income Approach
Historical, Projections, or Both?
 More common approach for small
businesses
 Still inherently making an assumption
on future earnings
 Considers last 1 to 3-5 years of
performance
 Interim period may be considered, but
skepticism warranted especially for
profitability margins
Capitalized Cash Flow Discounted Cash Flow
 Less common; important to understand
story of business
 Provides basis for capitalized cash flow
assumptions for revenue and
profitability
 Viewed cautiously and very use case
specific

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Normalization Adjustments
• Discretionary expenses are decided
based upon level of control
• Common normalization adjustments
which a minority owner cannot change
include officer’s compensation, related
party rent, or other non-business
expenses.
• Non-recurring expenses are normalized
as minority shareholder would not
expect reoccurrence of event
• Resulting income approach level of
value dictated by adjustments to cash
flow
Line Item 12/31/2020 12/31/2021 12/31/2022
Officer's Compensation (17,374) (22,600) (12,385)
Rent (10,466) (9,280) (8,058)
Taxes and Licenses (1,329) (1,729) (947)
Legal Expense - - (20,000)
Total Operating Expenses (29,169) (33,609) (41,391)
Line Item 12/31/2020 12/31/2021 12/31/2022
Officer's Compensation - - -
Rent - - -
Taxes and Licenses - - -
Legal Expense - - (20,000)
Total Operating Expenses - - (20,000)
Control Adjustments
Minority Adjustments
EBITDA 96,556 71,666 143,769
EBITDA Margin % 20.1% 16.4% 27.6%
SDE 154,182 124,066 206,384
SDE Margin % 32.1% 28.4% 39.6%
EBITDA 67,387 38,057 122,378
EBITDA Margin % 14.0% 8.7% 23.5%
SDE 142,387 113,057 197,378
SDE Margin % 29.7% 25.9% 37.8%

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Income Approach
Controlling Basis
• Results in controlling value
• Normalization adjustments related to
compensation and rent increase value
• Controlling shareholder can make such
adjustments to expense structure
• Represents liquid investment that can
be sold to a readily available market
and realized by a hypothetical buyer
Historical Terminal
Line Item 12/31/2020 12/31/2021 12/31/2022 Value
Total Revenue 480,218 436,665 521,791 521,791
Revenue Growth % n/a -9.1% 19.5% 0.0%
Weight (%) 0.0% 0.0% 100.0%
EBITDA 96,556 71,666 143,769 143,769
EBITDA Margin % 20.1% 16.4% 27.6% 27.6%
Weight (%) 0.0% 0.0% 100.0%
Less: D&A Expense (Tax Basis) 533 533 533 10,231
EBIT 96,022 71,133 143,235 133,538
EBIT Margin % 20.0% 16.3% 27.5% 25.6%
Income Taxes 25,926 19,206 38,674 36,055
Income Tax Rate % 27.0% 27.0% 27.0% 27.0%
Net Operating Profit After Tax (NOPAT) 70,096 51,927 104,562 97,482
NOPAT Margin % 14.6% 11.9% 20.0% 18.7%
Plus: D&A Expense (Tax Basis) 533 533 533 10,231
Less: (Increases)/Plus: Decreases in Cash Free Net Working Capital n/a (7,384) (3,739) 260
Less: Capital Expenditures n/a (142,235) n/a (10,436)
Free Cash Flow to the Firm n/a (97,159) n/a 97,538
Weighted Free Cash Flow to the Firm 97,538
Plus: Long-Term Growth Rate 103%
Long-Term Free Cash Flow to the Firm 100,464
Capitalization Rate (18.5% - 3.0%) 15.5%
Capitalized Cash Flow 648,154
Plus: Excess / (Deficient) Net Working Capital -
Plus: Net Nonoperating Assets / (Liabilities) -
Business Enterprise Value (Controlling, Rounded) 648,000

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Income Approach
Noncontrolling Basis
• Results in noncontrolling value
• Normalization adjustments related only
to nonrecurring expenses considered
• Minority shareholder cannot make such
adjustments to expense structure
• Discounts for lack of marketability to be
considered
Historical Terminal
Line Item 12/31/2020 12/31/2021 12/31/2022 Value
Total Revenue 480,218 436,665 521,791 521,791
Revenue Growth % n/a -9.1% 19.5% 0.0%
Weight (%) 0.0% 0.0% 100.0%
EBITDA 67,387 38,057 122,378 122,378
EBITDA Margin % 14.0% 8.7% 23.5% 23.5%
Weight (%) 0.0% 0.0% 100.0%
Less: D&A Expense (Tax Basis) 533 533 533 10,231
EBIT 66,854 37,524 121,845 112,147
EBIT Margin % 13.9% 8.6% 23.4% 21.5%
Income Taxes 18,050 10,131 32,898 30,280
Income Tax Rate % 27.0% 27.0% 27.0% 27.0%
Net Operating Profit After Tax (NOPAT) 48,803 27,392 88,947 81,867
NOPAT Margin % 10.2% 6.3% 17.0% 15.7%
Plus: D&A Expense (Tax Basis) 533 533 533 10,231
Less: (Increases)/Plus: Decreases in Cash Free Net Working Capital n/a (7,384) (3,739) 260
Less: Capital Expenditures n/a (142,235) n/a (10,436)
Free Cash Flow to the Firm n/a (121,693) n/a 81,923
Weighted Free Cash Flow to the Firm 81,923
Plus: Long-Term Growth Rate 103%
Long-Term Free Cash Flow to the Firm 84,380
Capitalization Rate (18.5% - 3.0%) 15.5%
Capitalized Cash Flow 544,388
Plus: Excess / (Deficient) Net Working Capital -
Plus: Net Nonoperating Assets / (Liabilities) -
Business Enterprise Value (Non-Controlling, Rounded) 544,000

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Controlling Versus Noncontrolling Value
Impact of Normalization Adjustments
Controlling Value
Noncontrolling Value
= $648,000
= $544,000
Inferred Discount for Lack of Control
= 16%

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Market Approach
What is Most Applicable?
 Seldom used
 Difficult to substantiate comparability
due to size factors
 Worthwhile to explore earning reports
and other industry commentary
(restaurants, etc.) on businesses
Guideline Public Company Guideline Transaction
 Transactions are on controlling basis
 More common approach for small
businesses
 Generally an abundance of data
 Revenue multiples supported by SDE
margin and growth

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Market Approach
Controlling Basis
• Results in controlling value
• Not appropriate to use minority cash
flows as multiples are on controlling
basis
• Discount for lack of control should be
applied to controlling value
• Minority shareholders do not have
ability to sell entire business
• Discounts for lack of marketability
should be applied to minority interest
• Most transactions reported as asset
sales and need to be adjusted to stock
transactions if estimating a minority
interest transaction
ID Target Name Sale Date Revenue SDE SDE
Rank / Coefficient of Variation 13 / 24 3 / 15 32.7%
Maximum 594,682 321,448 3.7x
75th Percentile 540,617 196,066 3.2x
Mean 517,040 157,090 2.5x
Median 521,850 164,044 2.2x
25th Percentile 491,351 108,533 1.9x
Minimum 406,808 48,512 1.1x
Selected Multiple 3.0x
Company Specific Adjustment 0.0%
Adjusted Multiples 3.0x
Last Fiscal Year as of December 31, 2022 206,384
Implied Business Enterprise Value 619,151
Weight (%) 100.0%
Initial Value as if Asset Sale 619,151
Add: Selected Assets 50,916
Less: Non Interest-Bearing Liabilities (37,963)
Business Enterprise Value (Controlling, Rounded) 632,000

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Reconciliation of Values
Controlling Basis
• Confirm all valuation conclusions are on
same level of control and marketability
• Consider valuation methods which
cannot be realized by minority buyer
(i.e. asset approach)
• If asset approach is highest consider if
other methods are still above purchase
price
• Discount for lack of control supported by
differences under income approach
• Businesses running optimally should
not have differences in estimated
financial control value between
controlling and minority shareholders
Valuation Method
Income Approach
Capitalized Cash Flow Method 648,000
Weight % 50.0%
Market Approach
Guideline Merged and Acquired Company Method: DealStats 632,000
Weight % 50.0%
Asset Approach
Adjusted Net Asset Method 350,453
Weight % 0.0%
Business Enterprise Value (Controlling, Marketable) 640,000
Plus: Cash 13,429
Less: Total Debt (37,000)
Fair Market Value of Common Equity (Controlling, Marketable, Rounded) 616,000
Subject Interest 30%
Fair Market Value of Minority Interest (Controlling, Marketable, Rounded) 185,000
Discount for Lack of Control (DLOC) 16.0%
Discount for Lack of Marketability (DLOM) 20.0%
Total Discount Factor 32.8%
Fair Market Value of Minority Interest (Noncontrolling, Non-marketable, Rounded) 124,000
Purchase Price 100,000
Purchase Price Conclusion ABOVE

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Frequently Asked Questions
• Q: What is a typical range of discounts for minority interests?
• A: While each minority interest is unique based upon the factors
discussed, a general expectation for cumulative discounts range
from 15% to 40%.

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• Q: What additional documents may be needed for a minority
interest valuation?
• A: The biggest additional document request would be the
proposed shareholder, operating, or partnership agreement which
is to be executed upon the completion of the transaction. This will
provide clear rights and privileges of the minority shareholder.

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• Q: Should the new minority interest owner compensation be
added to the normalized income statement?
• A: Case by case basis, but consider two main factors (1) is
existing owner expected to maintain same responsibilities and (2)
if new owner compensation is added has the additional return on
such labor been captured on the earnings side.

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• Q: What is the largest factor in estimating a discount for lack of
marketability?
• A: Generally, the expected distributions the minority shareholder
can expect to receive prior to a sale of the business. It is the only
return on its ownership it can receive prior to a sale. An interest
not receiving distributions is less marketable.

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Thank you! Questions?
Request a Quote
Brian McIntyre, CVA
Market Leader, Corporate Valuation and
SBA Loan Valuations
bmcintyre@withum.com
(856) 304 0455
Bryan DiMonte
Manager, Corporate Valuation and
SBA Loan Valuations
bdimonte@withum.com
(609) 429 5803

SBA Valuation Considerations for Partial Change of Ownership Transactions

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