There is a common characteristic between a manufacturing company and an MRI clinic: both tend to utilize expensive equipment ‐ equipment that lenders can use as collateral (assuming it is unencumbered). Accordingly, many lenders have engaged our firm to compile separate equipment appraisals for the fixed assets, instead of relying on the net book value. Unfortunately, the lender is often unsure how this impacts the total value of the business. In this article, I will explain in more detail how a business valuation and an equipment appraisal can be used together.
The Conclusion of Value
The conclusion of value in any business valuation includes all operating tangible and intangible assets. Tangible assets can include fixed assets such as furniture, fixtures and equipment, normally carried on the balance sheet at historic cost less the depreciation (“net book value”). Intangible assets can include goodwill, licenses and customer lists. The combination of these assets equals the total value of the business. Therefore, the final value includes all operating equipment ‐ adding the appraised equipment value to a business valuation would be double counting. So how do we separate the intangible and tangible assets?
The SOP 50 10 5(D) states: “The value of the intangible assets is determined by…the value of the business as identified in the business valuation minus the sum of the working capital assets and the fixed assets being purchased.” In other words:
intangible assets =
business value – (working capital + fixed assets)
The “working capital assets” are current assets minus current liabilities, calculated by using the most recent book value. In an asset sale, working capital assets would include only current assets (e.g., cash, inventory, A/R, etc.).
The “fixed assets” include furniture, fixtures, equipment and vehicles. SBA Information Notice 5000‐1096 states: “If the lender has obtained an appraisal for any real estate or machinery and equipment being acquired, the appraised value may be substituted for the book value for these assets.“
This means the net book value of the fixed assets must be used when estimating the value of fixed assets unless a certified third party equipment appraisal is compiled.
Let’s look at an example. Assume a printing company is appraised at $700,000. It is an asset valuation, and no current assets or liabilities are included in the purchase price / value (working capital is zero). Therefore, only the fixed assets are included in the value.
Scenario 1: The net book value of the fixed assets is $100,000. In order to estimate the value of intangible assets, the appraiser subtracts the net book value of the fixed assets from the total business value ($700,000 ‐ $100,000), which is $600,000. The lender’s collateral value calculation on the fixed assets must be based on the $100,000 net book value.
Scenario 2: A certified equipment appraisal was also ordered by the lender. The appraised fair market value of the fixed assets is $300,000. The business appraiser can now use the appraised value of the fixed assets in lieu of the net book value, which effectively decreases the value of intangible assets to $400,000 ($700,000 ‐ $300,000).
Scenario 2 provides the lender with the most accurate value for both tangible and intangible assets, as both assets were appraised separately. More importantly, the lender can use the appraised equipment value in lieu of the net book value, when determining collateral value for their loan.
The SOP 50 10 5(D) states, “If the purchase price of the business includes intangible assets … in excess of $500,000, the borrower and/or seller must provide an equity injection of at least 25% of the purchase price of the business for the application to be processed under delegated authority.”
By using the appraised equipment value in lieu of the net book value, the intangible assets in Scenario 2 are reduced to under $500,000 and therefore the borrower is not required to provide an equity injection of 25% in order for the loan to be processed under delegated authority (PLP).