Will the bank always do a business valuation when you apply for a loan?
As part of the business loan approval process, the bank may sometimes undertake a business valuation.
In saying that, it really depends on your business turnover and the amount you’re borrowing as to whether the bank decides to do this.
So how does a business valuation work?
A guide to business valuation
A business valuation is very different to valuations that are done for residential properties or even commercial properties.
As there isn’t any bricks and mortar in the business, the bank will base their valuation on the financials that you provide. You can help yourself in this process by making sure all of your financials are up-to-date and ready to present to the valuers.
Can you avoid a business valuation?
Banks tend not to do valuations on small businesses like cafes or retail store fronts. As a general rule, this applies to businesses turning over less than $1 million a year.
Specialised businesses like the ones mentioned above can be easily affected by market forces and the economy so values can fluctuate on a regular basis.
In fact, because the valuer will also be taking into account the state of the industry in which the business is operating and the location, the worst case scenario is that the bank may reduce your Loan to Value Ratio (LVR) and require you to come up with more security to purchase the business.
The bank’s risk appetite can change on a regular basis and even more so once a business valuation is done.
Are you just buying a commercial property to lease out?
We know how to build a strong case with the right lender so you can avoid being subject to a valuation.
Generally speaking, if you’re buying a standard commercial property, you won’t have to go through this process with the lender.
Call us on 1300 889 743 or fill in our free assessment form to find out if you qualify for a business loan and how we can get you a great deal.
When is the valuation done?
Once you’ve provided your most recent business financials, the bank will determine whether they will undertake a valuation of the business.
If so, they will contact a valuer that specialises in commercial property and businesses, the most common agencies being Manenti Quinlan and Herron Todd White.
You won’t have control over the valuation at this stage and, in fact, if it’s a specialised business, there would only be a handful of valuers in Australia that would have the expertise to complete such a valuation.
What methods do the banks use to valuate?
There are typically four main methods used by the banks when doing a business valuation.
Each of these methods aren’t used isolation. In fact, all four methods are used to arrive at a fairly accurate valuation.
As part of this process, the valuer will want to see to the latest profit and loss statements and balance sheets for the business as well as the latest company tax return (or personal income tax return if the business is being run as a sole proprietary).
You should consider using the exact same valuation techniques when looking for a business to buy!
It can help you in negotiating a fair price with the vendor.
This is the fairly straightforward process of subtracting the businesses existing liabilities (debts) from the value of its assets, such as cash, stock, equipment and machinery, and receivables.
For example, if the business has $400,000 in assets and $200,000 in liabilities, the net asset value of the business would be $200,000.
Working out the future return on investment (ROI) using the capitalisation rate (cap rate) is the most common way to value small businesses (SMEs).
The bank will start by calculating the average net profit of the business over the past 3 years using its yearly profit and loss (P&L) statements, subtracting the profit for one-off expenses or other irregular items during each financial year.
To work out the cap rate for a restaurant business, for instance, the bank would compare the average net profit of similar-sized restaurants.
After that, it’s just a matter of dividing the net operating income by the rate of return (the cap rate) and then multiplying that by 100.
For example, the cap rate for a cafe might be 10% so for a cafe turning over $50,000 a year, the valuer might put a price tag of $500,000 on the business, not including the assets if you’re also planning to the buy the property.
This involves the bank multiplying the business’ earnings before interest and (EBIT) by the same ROI or cap rate (10% in the cafe example).
This is usually done hand in hand with the cap rate valuation, particularly if it’s if the location of the business has a significant impact on profitability.
For instance, buying a transport business in a location where mining has slowed and the majority of your clients are steel manufacturers could see the business come in way under value.
Of course, sometimes it’s difficult to find comparable sales, particularly if you’re buying a purpose-built property along with the business.
Sometimes valuers will have to look at businesses in the next town just to find a comparable sale, which is where the use of the cap rate comes in handy.
Will goodwill be considered?
Generally speaking, the valuer won’t take into account goodwill in the business unless it’s a service-based business that relies on a “key man” or specific professionals to generate profit.
For example, a client is actually dealing with or being serviced by an accountant, a lawyer or a medical practitioner rather than the business manufacturing and sell a product.
There is value in the goodwill of these specialised businesses so the bank will be willing to lend against the value of the client book or trail book in these circumstances.
It just makes sense since an asset valuation alone would understate the true value in the business.
What else will the bank take into account?
- Outstanding debts: This refers to invoices that are yet to be paid by clients.
- Client contracts: They’ll be paying particular attention to major contracts for key clients and whether they’re coming to an end.
- List of suppliers: In particular, they’ll take into account contracts that are about to end or if any of the suppliers are going to increase their fees and charges. In this case, they may add a premium to the business’ liabilities.
- Lease remaining: The remaining years left on the lease is something that a business valuer will take note of and it’s also an important consideration for the bank. Ideally, the lease should have 3-5 years left with an option to renew.
- SWOT analysis: Throughout the entire valuation process, the bank will have specialist team analysing the strengths, weaknesses, opportunities and threats (SWOT) of the business. This includes whether there are direct competitors in the same location, whether there are upcoming zoning changes to the area and what the overall industry trends and threats are.
All of this contributes to the final value that the bank will place on the business, how much they’re willing to lend you and the interest rate and fees they will offer you.
Ultimately, the business valuation is based on if the business were to be sold today, not in the future.
What if I'm buying the freehold property as well?
If you’re buying the freehold along with the business as a going concern, the valuer will still undertake the valuation but the valuation report will be split between the freehold value and the going concern value of the business.
When valuing a commercial property, the valuer will be looking to see that the building and structure is fit for purpose and that plant, equipment, fixtures and fittings are all in good working order.
For a car yard or a petrol station, they may also run a soil test so that the land meets environmental legislation requirements.
How much does a valuation cost?
Like valuation for a residential property, you as the borrower must foot the bill for the business valuation.
The costs can vary anywhere between $2,000-$3,000 or up to $10,000 to even $20,000 if you want to buy a specialised property like a mechanical workshop or a pub as a freehold going concern.
Keep in mind though that this cost will be added to the top of your business loan (capitalised) once you’re approved.
Speak with a mortgage broker today
Do you need a business loan?
Please call us on 1300 889 743 or complete our free assessment form today.
We can help you prepare for your application and go with a lender that will offer you the most competitive interest rate and terms based on your financials.
Depending on how much you’re borrowing and the type of property that you’re buying, we may even be able to find a lender that can waive the need for a business valuation.