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Additional Perspectives Pertaining to SBA-Related Business Valuations

Both before and after the new SOP implementation, there has been a great deal of debate and confusion with respect to the roles played by the SBA’s SOP, FIRREA, the Code of Federal Regulations (CFR), Uniform Standards of Professional Appraisal Practice (USPAP) and the various professional standards associated with the business appraisal organizations such as the ASA, IBA, NACVA and AICPA.

After hours and hours of reading, contemplating, questioning and debating, I have reached the conclusion that the sources of confusion are related to a finite set of different definitions and interpretations which revolve around discrepancies between the following groups:

  1. Real property appraisers/appraisals and business appraisers/valuations.
  2. The old SOP versus the new SOP
  3. The old and new SOP versus USPAP
  4. USPAP versus Other Professional Standards, e.g. IBA, AICPA, etc.

Real Property Versus Business Appraisals

One of the challenges faced by lenders is the need to distinguish between the nuances of real property appraisals and business (going concern) appraisals. There has been a tendency to want to lump these two professions together, but there are in fact many important distinctions between the two realms. It is safe to say that one of the biggest obstacles to implementing business appraisals within the context of SBA loans has been the historical focus on real estate appraisals and real estate-specific terminology.

The differences go well beyond , of course. For example, business appraisers are NOT state-licensed as real estate appraisers can be – but they are “credentialed” (as now required via the new SOP). Despite the many differences, the first section of the new SOP which addresses “appraisals” utilizes a heading which would suggest that they are to be jointly considered. This section on page 176 (Subpart B, Chapter 4, Section 2, Subsection c) is titled “Appraisal and Business Valuation Requirements” and seems to imply that real estate is “appraised” and businesses are “valued” (appraisal versus valuation).

Among the real and important differences between these two areas, this distinction is not considered accurate from an academic perspective. In practice, real estate and businesses can be appraised or valued with no formal or official difference between the two terms. Nonetheless, the SOP consistently utilizes “appraisal” for real estate and “valuation” for businesses.

There are commonalities as well. For example, both real estate and business valuations (or appraisals) are subject to the same general (federal) regulations pertaining to “appraisal requirements”. Given that the Code of Federal Regulations (CFR) trumps the SBA’s SOP in terms of applicability, it is useful to recognize that:

“The regulations governing appraisal requirements are set forth at 13 CFR 120.160(b).”

As stipulated in the new (revised) version of SOP50-10(5) on page 176, the superiority of the CFR is duly noted. This common ground for real estate and business appraisals via the CFR extends into the required use of Uniform Standards of Professional Appraisal Practice (USPAP). Despite the common USPAP linkage, the fact is that business appraisal is covered within USPAP through its own set of limited professional standards (specifically number 9 for “developing the appraisal” and number 10 for “reporting the appraisal”), advisory opinions, etc. The current USPAP can be found at

It should be noted that there are not only substantive and procedural differences between the nature and attributes of real property appraisals versus business valuations (and appraisers versus valuators), there are significant differences between the SOP language and the terminology used by professional business appraisers. An SBA official recently referred to business appraisals as “evaluations” as a means of distinguishing between real estate (appraisals) and business engagements (valuations or evaluations).

According to the International Glossary of Business Valuation Terms (accepted by the major “credentialing” organizations in the BV realm), the preferred BV term is “valuation” (as follows):

Valuation – the act or process of determining the value of a business, business ownership interest, security, or intangible asset.

The following commentary helps to clarify the substance of differing opinions within the two different environments:

Viewpoint of SBA Administrator
"Appraisal vs. Valuation: These terms may be synonymous in the trade but they are not synonymous in the SOP. That was my point. The SOP does not speak the same language as those in the field offering appraisal and valuation services. And, by redefining terms with a long history of usage in the profession, we run the risk of sandbagging lenders when it comes time to make a purchase request.”

Differing Philosophical and Practical Interpretations

On a more substantive note, the same SBA Administrator also sought to clarify his view (and the SBA view, by inference) regarding the purpose of the valuation and the irrelevance of “fair market value” in the specific context of SBA-guaranteed acquisition financing:

“SOP 50-10 (5) 4. e. (5) 2. reads "The purpose of the independent valuation is to ensure that the buyer is not overpaying for the business which would result in overburdening the business with new debt that cannot be supported." At page 175 in the discussion of collateral in a change of ownership transaction, the SOP requires a business valuation to assure that the change in ownership not "...result in the buyer paying more for the business than the business's cash flow can sustain..." SBA, judging from the SOP, frankly does not care what the market value of the business is. I just don't want a lender to obtain an appraisal/valuation of the business that does not meet the expectations of the SOP and then have a loan purchase request denied or compromised."

It is the author’s opinion and experience that the lenders (and the SBA) do in fact care what the market value of a business is – or at least some measure of value (investment value or value to the owner?).

If the value were not relevant, then what is the purpose of mentioning acceptable valuation methods in the SOP and teaching these methods in various training courses? It is the author’s experience that the lenders do in fact seek out an estimate of value for purposes of comparing to the negotiated deal price. It is not a stretch to say that the lenders are primarily interested in seeing the final estimate of value above all other report components.

This is not to overlook the importance of evaluating the new owner’s ability to repay the acquisition debt and to assess the firm’s historic and the buyer’s future cash flow-generating capabilities. To the contrary, this is one of the most important services provided by a seasoned and professional business appraiser. In the final analysis, it behooves the business appraiser to accomplish both tasksgenerate an estimate of value AND evaluate the new owner’s ability to repay the acquisition-based and SBA-guaranteed loan. To their credit, the vast majority of lenders have done an exceptional and diligent job in terms of assessing historical and prospective business cash flows (accurately and conservatively).

As inferred earlier, terminology is clearly a major concern of business appraisers who have been trained to rely on a set of generally accepted valuation principles and procedures which includes the aforementioned “International Glossary of Business Valuation Terms”. For example, the cost, income and comparable sales “methods” described in the SOP are what business appraisers refer to generally as “valuation approaches, whereby each approach will be comprised of a number of different “methods”, i.e. approach is general and method is specific.

It seems that there is a silent battle of semantics between the SOP or “the way it has always been done or used” and the recent entry of professional business appraisers who have been trained in a relatively homogenous fashion by way of common terminology. The following definitions were taken from the BV Glossary:

Valuation Approach – a general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more valuation methods.

Valuation Method – within approaches, a specific way to determine value.

As already referenced, the battle of semantics and professional viewpoints extends into critical areas such as the purpose of the “valuation” or “evaluation”, with certain SBA personnel suggesting that the SOP does not require a determination of market value but rather an assessment of the capability of the business (and its new ownership) to repay the guaranteed loan. In this author’s opinion, however, such a notion flies in the face of other SOP components (old and new) which refer to the use of “generally accepted valuation methods” which can only be used to estimate market value (as opposed to assess the repayment probability) and which state clearly that:

“Determining the value of a business is the key component to the analysis of any loan application for a change of ownership. The need for an accurate valuation is true regardless of whether the financing is structured as an asset purchase or a business purchase.”

Note the portion which reads “determining the value of a business” and “accurate valuation”. After determining whether an estimate of value is required or not (yes, in the author’s opinion and the many lenders who request such valuations), the next area of contention revolves around the “standard of value”, e.g. fair market value or investment value or??.

Market Value, Fair Market Value, Investment Value Or??

This distinction and debate is largely of concern only to the appraisers, although the lenders can assist by clarifying the type of analysis which is preferred or sought within the 7(a) loan program. A number of appraisers have asked me if the analysis should include the impact of the new owner’s future debt service, whereby I have responded universally in the affirmative.

A certified business appraiser (and certain other “qualified” individuals) would know that a valuation analysis geared towards “evaluating the ability of the business to service the debt” does not necessarily generate an estimate of “fair market value” (unless a “hypothetical buyer” is assumed rather than the actual buyer, which would contradict the presumed intent of assessing “the added liability of new ownership/management”). At the same time, a business appraisal aimed at estimating fair market value should incorporate an assessment of the firm’s dividend-paying capacity as well as its ability to service debt.

It is true that the new SOP includes the following language which could be interpreted in a manner consistent with the SBA official, but why should we (lenders, appraisers and “qualified evaluators” alike) be forced to decipher what should be as clear as day?

“Because a change of ownership may result in the buyer paying more for the business than the business’s cash flow can sustain, especially with the added liability of new ownership/management, a lender must meet additional SBA requirements for this type of use of proceeds when the loan amount is more than $350,000.”

As repeated elsewhere, it has been this valuator’s experience that SBA lenders are clearly and universally looking for the business appraiser to provide an estimate of value. The key question, of course, is what type of value? The concept of Fair Market Value was retired from USPAP a number of years ago at which time that nomenclature had an entirely different meaning from Market Value (the term was actually “fair value” as in the legal or regulatory sense of the concept). At present, there is not a great deal of difference between “market value” (as defined in USPAP) and “fair market value” as defined by the International Glossary of Business Valuation Terms.

The following definition is provided in FIRREA and also in the 2009 USPAP Advisory Opinion 30 (Obligations for Appraisers Performing Appraisals for Use by a Federally Regulated Financial Institution).

FIRREA and AO-30 Definition of Market Value

(g) Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition are the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

  1. Buyer and seller are typically motivated;
  2. Both parties are well informed or well advised, and acting in what they consider their own best interests;
  3. A reasonable time is allowed for exposure in the open market;
  4. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
  5. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

This definition is generally consistent with the common interpretation of fair market value (as used by business appraisers) and USPAP requires that the appraiser cite the relevant standard of value and include the source of the definition. The current USPAP also includes a definition of “market value” (with nothing included for “fair market value” or “investment value”) which, not surprisingly, is focused primarily on real estate appraisals:

USPAP Definition of Market Value

MARKET VALUE: a type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal.

Comment: Forming an opinion of market value is the purpose of many real property appraisal assignments, particularly when the client’s intended use includes more than one intended user. The conditions included in market value definitions establish market perspectives for development of the opinion. These conditions may vary from definition to definition but generally fall into three categories:

  1. the relationship, knowledge, and motivation of the parties (i.e., seller and buyer);
  2. the terms of sale (e.g., cash, cash equivalent, or other terms); and
  3. the conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale).

Appraisers are cautioned to identify the exact definition of market value, and its authority, applicable in each appraisal completed for the purpose of market value.

Whether “market value” or “fair market value” or “investment value” (IV) or any other standard of value is utilized, the appraiser must disclose and define the chosen standard of value.
Furthermore, it makes sense that the lender should have a say in this determination, i.e. the lender and the appraiser should work together towards developing the pertinent “scope of work” in accordance with current USPAP requirements. This decision should also reflect the target of the appraisal/valuation, i.e. it should match the type of property (real property or a business interest).

Although most business appraisers performing valuations for SBA loan purposes will rely on a definition of fair market value, there is ample evidence in the prior and new SOP to suggest than “investment value” might be more appropriate. Investment value is defined in the International Glossary of BV Terms as follows:

Investment Value
The value to a particular investor based on individual investment requirements and expectations. {NOTE: in Canada, the term used is "Value to the Owner"}.

Note that the use of “investment value” does not preclude the presence of an “arm’s length transaction” (as required by the SOP). Consider the following discussion from the prior SOP (page 194):

(1) Arm's-Length Transaction
Loan proceeds may only be used to effect a change of ownership that is an arm's length transaction. A transaction is at arm's length if it is a reasonable representation of the fair market value, the price which an independent buyer would be willing to pay.

In other words, the value to a specific and known buyer in the SBA realm is the value to an independent buyer – but an independent buyer with “known” attributes, skills, relationships and other qualities such as working capital funds, other potential investors, etc.

Just a few examples of where the SBA's written policies have historically inferred the use of a type of "investment value" even if they used the term "fair market value" or “market value” (which I believe is due to the historical importance of real property appraisals as opposed to business appraisals):

  • SOP 50-10(4)(B) Paragraph 3b. (2)
    One of the acceptable methods is "discounted future earnings"
  • Paragraph 3b. (3)
    Suggested analysis includes "Is the buyer presently an employee of the firm who already knows the market or is the buyer an inexperienced newcomer?"
  • Paragraph 3c.
    States that "the proforma balance sheet shall be prepared to reflect what the business will look like on the date ownership transfer occurs."

Each of these items infers an element of investment value or consideration of the business (value) from the perspective of the "known" buyer. Consider this thought as well - if a strict fair market value determination were made (hypothetical buyer and hypothetical seller), what would be the purpose of interviewing the buyer at all? All assumptions would be made based on the actions of a "hypothetical" buyer with "typical" expense ratios, typical capital structure, etc. In the end, one is valuing the "typical" business and not the actual business. This type of FMV analysis is necessary when there is NO buyer involved, e.g. estate/gift taxes, shareholder disputes, ESOP's - but not when there is a known buyer with known skills and attributes (or lack thereof).

If investment value is the most relevant (or at least relevant) standard of value, then the various issues related to “strategic buyers” and “economies of scale” or “synergies” should be considered. It is not uncommon for the seller of a business to remain fully engaged in the business after the sale for a full year (and even longer despite recent limits established in the new SOP). It is not difficult to recognize that many businesses will fare much better “in the future” if the seller remains involved for a full year – especially when the combined efforts of the seller and the new owner are mutually complimentary and the “management team” is in effect expanded and deepened. Should this be ignored when performing a valuation for SBA loan purposes? Answer this question based on the notion that the primary task of the valuation is to assess the probability of repayment?

The challenge at hand is that the SOP as it stands today does not address the standard of value issue directly, leaving it to the discretion and common sense of the lender and the appraiser (once again working together to craft the appropriate scope of work).

The policy also does not provide a definition of Liquidation Value or the circumstances under which it would be appropriate, but USPAP once again requires consideration of the fact that the business might be worth more “in parts”. A liquidation value does not have the same definition as a Market Value and must be defined so that the appraiser can determine the appropriate scope of work. As one seasoned appraiser stated, “Is this a “Go Dark/Net Realizable Value Opinion” or just an abbreviated seller marketing period?”

Assuming that business appraisers should or must follow USPAP (in addition to their own professional standards), it is natural to wonder next what is meant by “scope of work” and what is considered appropriate. According to USPAP, the scope of work is the work an appraiser performs to develop assignment results. USPAP defines “scope of work” as the type and extent of research and analyses in an assignment. Note that this definition excludes reporting.

In fact, the considerations related to the determination of “scope of work” lie at the heart of the most significant sources of confusion and debate among professional business appraisers. As addressed already, one difference of opinion revolves around the difference between “fair market value” (based on a hypothetical buyer and seller) and “investment value” (value to a specific or known buyer and seller).

The commonly held position among certain SBA personnel that the assessment of the probability of repayment (at a given deal price which is financed with government guaranteed funds) is paramount to the analysis and conclusion reached by the independent appraiser is more consistent with the “investment value” standard than the “fair market value” standard which is most often referenced in practice and in engagement documents between the lender and business appraiser.

In short, the determination of pure fair market value fails to directly and fully consider the specific implications associated with the background, skill and motivation of the borrower/applicant and therefore fails to directly and fully assess the probability of repayment. Ignoring the specific skills and plans put forth by the borrower/buyer in favor of a “hypothetical” buyer is contradictory to the SOP that emphasizes the need to verify that the asking price is supported by historic operations and that the new ownership will be able to service the new debt. As noted on page 179 in the new SOP:

“An accurate business valuation is required because the change in ownership will result in new debt unrelated to business operations and create “blue sky” or goodwill. A business valuation assists the lender and the buyer in making the determination that the seller’s asking price is supported by historic operations.”

Similar points are sprinkled throughout the SOP, including those noted earlier and the following on page 178:

“When the loan will finance a change of ownership, a lender must meet additional requirements when the loan amount is more than $350,000 to ensure that the buyer is not paying more for the business than its cash flow can sustain.”

Self-Contained Report Versus Summary Report

Another unsettled (and related) area concerns the type of report to be prepared by business appraisers when performing the requested valuation. The standard of value and report type are “related” in that they both could or should be addressed in the “scope of work” determination. The type of report is important for a number of reasons including the cost associated with its preparation.

The primary source of confusion today is once again the historical attempt to lump the business appraisals in with the real estate appraisals – despite their obvious differences. Secondarily, the differing evolution of USPAP versus the SOP is contributing to the uncertainty.

Besides report content, lenders (loan officers) are often concerned with the type and amount of costs associated with an appraisal given that they must normally be passed on to the borrower (or taken out of profit). There are a number of different terms which have been used to connote various report types and their corresponding content.

SBA lenders are familiar with terms such as complete, limited, self-contained, summary and restricted use. The USPAP and the professional business appraisal organizations also utilize report types such as oral, written, formal, preliminary (IBA) or “valuation engagement” versus “calculation engagement” (AICPA) and many others. As clarified later, USPAP includes only two possible report types for business valuations (Appraisal Report and Restricted Appraisal Report as per Standard 10-2) compared to three report types for real property appraisals. For better or worse, the various professional BV organizations also have their own terms which describe report options.

Within the SBA realm, it seems proper to limit the possible report options to those presented in either the new SOP or USPAP (while using other report types for explanatory purposes). As per the introductory section in the new SOP50-10(5) on page 176, there are four different asset groupings that are subject to appraisal or valuation (and appraisal or valuation reports) which are addressed in further detail:

  1. Commercial Real Estate
  2. Non-Commercial Real Estate (or real estate securing a personal guaranty)
  3. Other Fixed Assets
  4. Change of Ownership – Additional Requirements

It is interesting to note that this first SOP section involving the appraisal of commercial real estate clearly and unequivocally mandates the use of USPAP (Uniform Standards of Professional Appraisal Practice) as follows:

(iii) The appraisal must be prepared in compliance with Uniform Standards of Professional Appraisal Practice (USPAP) and use one of the following options:

  1. a self –contained appraisal report; or
  2. a summary appraisal report

Although included in a section with a heading that infers both real estate and business valuations are addressed, this assumption falls short upon closer scrutiny. As just seen, the SOP goes beyond a general USPAP mandate and proceeds to delineate the specific types of appraisal reports which are acceptable (self-contained or summary). This leads to two different but equally important considerations.

First, there is no such clear and unequivocal mandate in the SOP for business appraisers to follow USPAP (the precedence of the CFR over the SOP, however, suggests that business appraisals must also be prepared in accordance with USPAP).

Second, business appraisers do not have the identical choice due to the specific guidance offered through Standards 9 and 10 (applicable specifically to business valuation assignments as opposed to Standards 1 to 8 which apply specifically to real property valuation assignments). In short, the business appraiser who follows USPAP must choose between an “Appraisal Report” or a “Restricted Use Appraisal Report”.

According to the prior SOP50-10(4) publication, every (real estate) appraisal must be prepared under one of three report options (a “self-contained”, “summary” or “restricted appraisal report” are the options, with the latter severely limited in its usage) with the primary distinction between a “self-contained” and “summary” appraisal report a function of “the level of presentation”.

Specifically, the prior SOP reads as follows:

SUMMARY APPRAISAL REPORTS must include all of the items required in a SELF-CONTAINED APPRAISAL REPORT, except the level of presentation can be less detailed or summarized for items (a), (f), (h), (i) and (k), listed above.

In order to appreciate the difference between these two report options, the areas which can be LESS DETAILED in the summary appraisal reports are highlighted in bold, underlined italics below:


  1. Identify and describe the real estate being appraised;
  2. State the real property interest being appraised, including legal description and known encumbrances;
  3. State the purpose and intended use of the appraisal;
  4. Define the value (cost, income, or comparable sales) to be estimated;
  5. State the dates of the appraisal and the report;
  6. State all assumptions and limiting conditions that affect the analysis, opinions, and conclusions;
  7. State the extent of the process of collecting, confirming, and reporting data;
  8. Describe the information considered, the procedures followed, and the reasoning that supports the analysis, opinions, and conclusion;
  9. Describe the appraiser's opinion of the highest and best use of the real estate, when such an opinion is necessary and appropriate;
  10. Explain and support the exclusion of any of the usual valuation approaches;
  11. Describe any additional information that may be appropriate and explain any departures; and
  12. Have a signed certification by the appraiser.

According to this interpretation, the difference between a self-contained and summary report is simply the level of detail. Bear in mind that this discussion applies first and foremost to real estate appraisals. It is NOT clear that the same considerations apply to business valuations (recall that USPAP mandates different report types for business appraisers).

Whereas the SOP50-10(5) document is “silent” as to the options applicable to business valuators, USPAP Standards 9 and 10 differentiate between an “Appraisal Report” and a “Restricted Use Appraisal Report”.

Appraisal Versus Restricted Use Appraisal

Similar to the distinction between “self-contained” and “summary”, the distinction between “appraisal report” and “restricted use appraisal report” is in the content and level of information provided. Besides the differences which will be introduced shortly related to the specific list of items to consider in these two different report options, another important difference involves the verb choice related to the required action of the appraiser (as follows):

Appraisal Report
Primary action verb: Summarize

Restricted Use Appraisal Report
Primary action verb: State

As noted above, the more complete “Appraisal Report” requires the appraiser to “summarize” key components as opposed to simply “state” these components. The appropriate reporting option and the level of information necessary in the report are dependent on the intended use and intended users. The new USPAP includes the following clarification of interest:

“When the intended users include parties other than the client, an Appraisal Report must be provided. When the intended users do not include parties other than the client, a Restricted Use Appraisal Report may be provided.”

In contrast to the “Self-Contained Report” option for real property appraisals and appraisers, its business appraisal counterpart (Appraisal Report) goes a different direction in terms of required content which relates specifically to business interests. The new requirements are updated to reflect generally accepted valuation principles and procedures and include the need to discuss elements of control and marketability (or lack thereof). For example, the 2003 USPAP edition did not include coverage of marketability issues. The newest version also requests a formal definition of the standard of value along with the “source” of the definition.

It is frankly illogical and cumbersome to try and place the business valuation reporting requirements into the real estate appraisal reporting framework. Furthermore, it is not necessary given the presence of USPAP Standards 9 and 10. USPAP Standard 10-2 describes the content of both the Appraisal Report and Restricted Appraisal Report with the Appraisal Report contents presented here:

(a) The content of an Appraisal Report must be consistent with the intended use of the appraisal and, at a minimum:

  1. state the identity of the client and any other intended users, by name or type;(note113 )

    Comment: An appraiser must use care when identifying the client to ensure a clear understanding and to avoid violations of the Confidentiality section of the ETHICS RULE. In those rare instances when the client wishes to remain anonymous, an appraiser must still document the identity of the client in the workfile but may omit the client’s identity in the report.

  2. state the intended use of the appraisal;(note114 )
  3. summarize information sufficient to identify the business or intangible asset and the interest appraised;

    Comment: The identification information must include property characteristics relevant to the type and definition of value and intended use of the appraisal.

  4. state the extent to which the interest appraised contains elements of ownership control, including the basis for that determination;
  5. state the extent to which the interest appraised lacks elements of marketability and/or liquidity, including the basis for that determination;
  6. state the standard (type) and definition of value and the premise of value and cite the source of the definition;

    Comment: Stating the definition of value also requires any comments needed to clearly indicate to the intended users how the definition is being applied.

  7. state the effective date of the appraisal and the date of the report;

    Comment: The effective date of the appraisal establishes the context for the value opinion, while the date of the report indicates whether the perspective of the appraiser on the market or property as of the effective date of the appraisal was prospective, current, or retrospective.

  8. summarize the scope of work used to develop the appraisal;(note115 )

    Comment: Because intended users’ reliance on an appraisal may be affected by the scope of work, the report must enable them to be properly informed and not misled. Sufficient information includes disclosure of research and analyses performed and might also include disclosure of research and analyses not performed.

    When any portion of the work involves significant business and/or intangible asset appraisal assistance, the appraiser must summarize the extent of that assistance. The signing appraiser must also state the name(s) of those providing the significant business and/or intangible asset appraisal assistance in the certification, in accordance with Standards Rule 10-3.(note116 )

  9. summarize the information analyzed, the appraisal procedures followed, and the reasoning that supports the analyses, opinions, and conclusions; exclusion of the market approach, asset-based (cost) approach, or income approach must be explained;

    Comment: An Appraisal Report must include sufficient information to indicate that the appraiser complied with the requirements of STANDARD 9. The amount of detail required will vary with the significance of the information to the appraisal.

    The appraiser must provide sufficient information to enable the client and intended users to understand the rationale for the opinions and conclusions, including reconciliation in accordance with Standards Rule 9-5.

  10. clearly and conspicuously:
    • state all extraordinary assumptions and hypothetical conditions; and
    • state that their use might have affected the assignment results; and
  11. include a signed certification in accordance with Standards Rule 10-3.

As noted in USPAP Standard 10-2, “An appraiser may use any other label in addition to, but not in place of, the label set forth in this Standard for the type of report provided.”, i.e. the terms may still be used as long as they are adequately identified and defined. USPAP requires the appraiser to determine the appropriate scope of work given the appraisal problem. As such, the onus appears to fall primarily on the appraisal profession. The challenge in this regard is the requirement that the lender request the appraisal (and presumably stipulate, at least in part, the scope of work).

Complete Versus Limited Reports

Another set of options facing the appraiser concerns the choice between a “complete” or “limited” appraisal. Despite the USPAP’s elimination of these terms in the 2008/2009 edition, the SBA’s SOP50-10 duo (old and new) have their own take on the distinction between complete and limited.

In both the old and new SOP’s, the distinction is quite straightforward and involves the following attributes:

Complete Appraisal (New SOP)
Details all three methods of valuation (cost, income and comparable sales).

Limited Appraisal (New SOP)
Does not use all three methods (but SBA requires use of “cost” and “comparable sales” valuations).

The difference, therefore, revolves solely around the number of valuation approaches that are utilized. As is often the case, there are differences between the SOP and USPAP which require careful consideration.

For another useful perspective, the valuator obtained an Arizona-based real property appraisal performed in 2005 (before the USPAP changes) and located the following disclosure under the heading of “Appraisal and Report Identification”:

Complete Appraisal (USPAP)
The act or process of estimating value, or an opinion of value, performed without invoking the Departure Rule.

Limited Appraisal (USPAP)
The act or process of estimating value, or an opinion of value, performed under q and resulting from invoking the Departure Rule.

From this perspective, the difference between a complete and limited appraisal relates to the use (or avoidance) of the so-called “Departure Rule”. As mentioned already, the terms of “complete” and “limited” were retired in the 2008 USPAP and replaced by the Scope of Work Rule due to continued confusion regarding the definition of those terms.

As mentioned elsewhere, the business valuation side of the SBA realm is further complicated by the fact that each “credentialed” appraiser is obligated to abide by their respective organization’s set of professional standards. Each of the four groups identified in the new SOP (ASA, IBA, NACVA, AICPA) have created their own set of standards (which also differ considerably in their format but less so in their content). In general, they are considered to be consistent with USPAP and certain organizations have obligated their members to follow USPAP as well as the group’s standards.

Similar to the prior years’ USPAP, the professional standards of the Institute of Business Appraisers (IBA) also make reference to the “departure” concept within their “Standard Six: Preliminary Reports”. As such, the IBA’s “preliminary report” is akin to the old USPAP’s “limited appraisal”.

The IBA defines a “preliminary report” as follows:

Preliminary Report (IBA)
A brief oral or written report reflecting the appraiser’s limited opinion. A preliminary report must clearly identify any valuation as a “limited” opinion of value as the appraiser has not performed the detailed investigation and analysis essential to a cogent appraisal (See Standard 6.5).

Standard 6.5 is titled “Departure” and reads as follows:

Standard 6.5: Departure (Preliminary Report)
If an appraiser makes a preliminary report without including a clear statement that it is preliminary, there is the possibility that a user of the report could accord the report and its limited opinion of value a greater degree of accuracy and reliability than is inherent in the preliminary report process. Therefore, all preliminary reports shall include a Statement of Departure in accordance with Standard 1.21(b). The Statement of Departure shall include a statement that the report is preliminary and the conclusion subject to change following a proper appraisal and that said change could be material.

To complete the coverage of the IBA standards, Standard 1.21 (Departure) shall be presented:

Standard 1.21: Departure (General)
A business appraiser may be engaged to perform an appraisal assignment that calls for something different from the work that would routinely result from the appraiser’s compliance with all must standards; provided, that prior to entering into an agreement to perform such an assignment:

  1. The appraiser is of the opinion that the assignment is not so limited in scope that the resulting report would tend to mislead or confuse the client or other anticipated readers; and
  2. The appraiser has advised the client that the assignment calls for something different than that which would normally result from compliance with applicable standards and, therefore, the report shall include a statement of departure.

Whether referring to the old USPAP (departure rule), the new USPAP (scope of work) or the IBA Professional Standards (preliminary report), the distinctions between the “complete” and “limited” report options revolve around a departure from “the norm” of what is expected with respect to a full-blown, formal, self-contained business valuation.

IBA Standard 6.3 reads that “The preliminary report has use when a client desires the appraiser’s limited opinion”. Once again, therefore, it is incumbent on the client (lender) to make such a request and it is incumbent on the appraiser and client to discuss and memorialize the specific nature of the current assignment (its “scope of work”).

In practice, the departure rule could be used when only one valuation method was to be utilized or if the appraiser were not planning on performing a site visit. Whatever the departure might be, proper documentation and disclosure is the key to remaining compliant with applicable standards and common sense.

As is typically the case, the ideal situation involves an equal and proactive participation on the part of the appraiser and the client to determine the precise nature and magnitude of the “scope of work” so as to avoid any future problems. One of the “Q&A” topics on the current USPAP webpage addresses this relationship:

Question: Is a scope of work specified by the client acceptable?

Response: It is if that scope of work allows the appraiser to develop credible assignment results. If the scope of work specified by the client does not allow the development of credible assignment results, the appraiser needs to discuss changing the scope of work or withdraw from the assignment.

Accordingly, the “mutual determination” of the scope of work would not only be logical and beneficial in the SBA realm, it is clearly acceptable as per USPAP. According to the “scope of work rule”, each appraisal, appraisal review, and appraisal consulting assignment, an appraiser must:

  1. identify the problem to be solved;
  2. determine and perform the scope of work necessary to develop credible assignment results; and
  3. disclose the scope of work in the report.

An appraiser must properly identify the problem to be solved in order to determine the appropriate scope of work. The appraiser must be prepared to demonstrate that the scope of work is sufficient to produce credible assignment results.

Comment: Scope of work includes, but is not limited to:

  • the extent to which the property is identified;
  • the extent to which tangible property is inspected;
  • the type and extent of data researched; and
  • the type and extent of analyses applied to arrive at opinions or conclusions.

Appraisers have broad flexibility and significant responsibility in determining the appropriate scope of work for an appraisal, appraisal review, and appraisal consulting assignment.

More About the Scope of Work

Given the precedence of USPAP over the SOP via the CFR and FIRREA (in general), it is helpful to see what else the Appraisal Standards Board (ASB) has to say about the differences between these reporting options. Given the recent elimination of the “self-contained” and “summary” report options, it is ultimately a matter of properly determining and defining the “scope of work”.

Naturally, the appraiser cannot accomplish this in a vacuum and the assistance and guidance of the client (the lender) is required in order to successfully fulfill all the parties’ obligations. Accordingly, it is incumbent upon the lender to not only formally request the appraisal (as per the SOP) but also to outline and highlight the desired attributes of the requested valuation analysis.

Whether “self-contained” or “summary” or “complete” or “limited”, there should be a detailed and specific request put forth which highlights (among other things) the following:

  1. Description of business interest to be valued and desired effective date
  2. Pertinent standard and premise of value
  3. The valuation methods to be applied
  4. The depth and breadth of company, industry and economic analysis
  5. Intended use of report and identity of the client
  6. Other relevant valuation considerations including the importance placed on the specific contributions of the known buyer on the firm’s future financial performance (and hence the firm’s value).

It is difficult to quantify areas such as “depth and breadth of analysis”, but this does not preclude the parties from attempting to refine the typical “scope of work” associated with SBA-related business valuations. In making the decision between a lesser or more thorough valuation analysis and report, there are numerous factors which should be considered.

One of the nation’s leading SBA lenders recently grappled with determining those circumstances which warranted the additional work (and cost) associated with more detailed valuation analyses, i.e. in distinguishing between a “self-contained and complete” report versus a “summary and limited” report. In so doing, I was asked to prepare a list of factors which would in effect argue in favor of more detailed (and therefore more time-consuming and more costly) analysis.

In light of the absence of specific guidelines regarding the use of summary versus self-contained (or “limited” versus “complete”) reports with respect to business valuations in the new SBA SOP50-10(5) publication, it would seem logical to consider those particular circumstances which might warrant the added scrutiny and evaluation which comes with the more complete or comprehensive option available to SBA lenders.

While attempting to balance the need for credible and accurate valuation results with the higher costs associated with comprehensive appraisal work, there may be certain criteria which could be used to help make the proper trade-off in this regard. Underwriters have always had and will continue to have the option to request a comprehensive report at any deal value – if they are uncomfortable with one or more aspects of the deal and seek the additional review and analysis in self-contained reports.

Besides the obvious criteria of deal price, the following factors might also be considered in reaching a final decision as to which report type/length to request. For lack of a better “term”, I will refer to such reports as “comprehensive”:

Potential Criteria for Requesting “Comprehensive” Business Appraisals

  1. Buyer’s cash down payment, e.g. if only 10% versus 20% or 30%.
  2. Deal involves related parties or company employees/close friends.
  3. Buyer lacks documented entrepreneurial experience and/or direct industry experience.
  4. Business type/category has above average SBA default or charge-off rate based on current data.
  5. Loan is under-collateralized relative to norm or to some other benchmark.
  6. Buyer’s projected revenues and earnings during first year are more than 15% higher than the most recent historical performance or the average from the three most recent years.
  7. Buyer submits forecast which is not carefully documented with assumptions that are supported by fact or other relevant information.
  8. Business generates more than 50% of revenues or earnings from a single customer or a single contract.
  9. Future success of business depends in large part on the continued presence of the seller (for at least the one full year that is allowed under the new SOP).
  10. Business is a “cash business” with revenues that may not be properly documented.
  11. Sum of owner perks and other miscellaneous adjustments exceed magnitude of straight profits (excessive addbacks).

Additional Coverage of “Scope of Work” Considerations

In order to round off the discussion herein regarding scope of work, the valuator has obtained USPAP advisory opinions which further clarify this newly important valuation topic.

According to Appraisal Standards Board (ASB) Advisory Opinion 29,

The SCOPE OF WORK RULE states that an appraiser’s scope of work is acceptable when it meets or exceeds:

  • the expectations of parties who are regularly intended users for similar assignments; and
  • what an appraiser’s peers’ actions would be in performing the same or a similar assignment.

Assignments are similar when the assignment elements used to identify the appraisal problem are comparable. Assignment elements include such things as the intended use, intended users, type and definition of value, effective date, relevant characteristics of the subject property, and assignment conditions.

The scope of work is acceptable when it leads to credible assignment results. The SCOPE OF WORK RULE establishes two benchmarks for measuring the acceptability of the scope of work, both of which need to be met. The scope of work is acceptable when it meets or exceeds both (1) the expectations of parties who are regularly intended users for similar assignments; and (2) what an appraiser’s peers’ actions would be in performing the same or a similar assignment. An acceptable scope of work must satisfy both benchmarks.

Problem Identification

Problem identification is the beginning point of every assignment. The appraiser must gather and analyze the information needed to properly recognize the appraisal, appraisal review, or appraisal consulting problem to be solved. The information necessary for problem identification is presented in each Standard that addresses the development process for an appraisal, appraisal review, or appraisal consulting assignment. For example, Standards Rules 1-2, 6-2, 7-2 and 9-2 provide the assignment elements that must be defined and analyzed in order to identify the problem to be solved in an appraisal assignment. These assignment elements include the:

  • client and any other intended users;
  • intended use of the appraiser’s opinions and conclusions;
  • type and definition of value;
  • effective date of the appraiser’s opinions and conclusions;
  • subject of the assignment and its relevant characteristics; and
  • assignment conditions

Identifying the problem to be solved is required in order to make critical judgments in determining the appropriate scope of work. Therefore, the assignment elements necessary for problem identification in an appraisal, appraisal review, or appraisal consulting assignment also serve as reference points in determining whether the scope of work performed was appropriate to provide credible assignment results.

Additionally, proper identification of the problem to be solved is required for compliance with the COMPETENCY RULE, which states:

Prior to accepting an assignment or entering into an agreement to perform any assignment, an appraiser must properly identify the problem to be addressed and have the knowledge and experience to complete the assignment competently; or alternatively, must… (Bold added for emphasis).

One of the elements that affects the scope of work is assignment conditions. Some assignment conditions are not a matter of choice, such as an inability to inspect a property because it has been destroyed. Other assignment conditions are a matter of choice, such as a client’s request to perform a desktop appraisal of machinery and equipment to reduce fees.

Determining and Performing the Scope of Work (AO-28)

USPAP recognizes that the appropriate scope of work may differ significantly for different assignments; the SCOPE OF WORK RULE provides flexibility in determining the scope of work. The competency necessary to determine an appropriate scope of work within the allowed flexibility resides with the appraiser. Therefore, while it is common and reasonable for the client to provide input to the appraiser regarding a desired scope of work, the responsibility for determining the appropriate scope of work resides with the appraiser.

The flexibility and responsibility are linked in the SCOPE OF WORK RULE when it states:

Appraisers have broad flexibility and significant responsibility in determining the appropriate scope of work for an appraisal, appraisal review, and appraisal consulting assignment.

This responsibility is described when the SCOPE OF WORK RULE states:

The appraiser must be prepared to demonstrate that the scope of work is sufficient to produce credible assignment results.

The client, for example, might request that the appraiser include, or exclude, specific inspections, data collection, or analysis in the scope of work. The appraiser may accept an assignment with these types of assignment conditions provided that the assignment results are credible in the context of the intended use. The SCOPE OF WORK RULE addresses this issue in the Scope of Work Acceptability section:

An appraiser must not allow assignment conditions to limit the scope of work to such a degree that the assignment results are not credible in the context of the intended use.

An appraiser must not allow the intended use of an assignment or a client’s objectives to cause the assignment results to be biased.

Determining the appropriate scope of work requires judgment. This judgment rests on the appraiser’s identification of the assignment elements and understanding of what is required to solve the identified problem. In many assignments, experienced appraisers are able to make this judgment about the appropriate scope of work quickly because they have performed many assignments addressing a similar problem to be solved (assignment with similar assignment elements). In other assignments, the determination of the appropriate scope of work may require more analysis by the appraiser because the problem to be solved has certain unusual characteristics. In yet other assignments, the appraiser may begin with a planned scope of work but in the course of the assignment find that the planned scope of work must be modified in order to produce credible assignment results.

The SCOPE OF WORK RULE recognizes that the scope of work actually performed may differ from the scope of work initially planned, when it states:

Determining the scope of work is an ongoing process in an assignment. Information or conditions discovered during the course of an assignment might cause the appraiser to reconsider the scope of work.

Disclosing the Scope of Work Performed (AO-28)

The SCOPE OF WORK RULE explains that proper disclosure of the scope of work:

…is required because clients and other intended users rely on the assignment results.

The Rule also states that:

The report must contain sufficient information to allow intended users to understand the scope of work performed.

An appraiser must disclose research and analyses not performed when such disclosure is necessary for intended users to understand the report properly and not be misled.

These disclosure requirements apply to the scope of work performed, rather than the scope of work initially planned by the appraiser. The appraiser must disclose the type and extent of research and analyses that were actually completed in the development process. Additionally, the information required to allow intended users to understand the scope of work may include disclosure of research and analyses not performed. There is no requirement for the scope of work description to be in a particular or separate section of the report.

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