DOCSLIB.ORG

The Economic Analysis of Real Option Value Robert P

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
The Economic Analysis of Real Option Value Robert P Stock Option Valuation Insights Thought Leadership The Economic Analysis of Real Option Value Robert P. Schweihs The discounted cash flow method does not always completely capture the uncertainty of the future financial performance of a business, business ownership interest, or security that is the subject of a valuation analysis. In those instances, when the valuation purpose should take into consideration the owner/operator’s ability to influence the future financial performance of the subject investment, then real option valuation (ROV) theory is a powerful analytical tool. ROV analysis is often used by corporate acquirers—and by other investors— who are more interested in the question “what is this investment worth to me?” than they are in the question “what is the market value of this investment?” NTRODUCTION be justified by the intrinsic valuation of the subject I investment. These investors are admired (particu- The current market price of a publicly traded secu- larly if they are successful) as risk takers who invest rity may be inconsistent with the net present value perhaps on a “hunch.” cash-flow-based intrinsic valuation of that security’s This discussion considers how ROV theory may price. That is, the intrinsic valuation of the security explain some of that intuition. This discussion con- (based on a discounted cash flow valuation analysis) siders how investment risk takers can better handle may simply not support the apparently excessive uncertainty when they have the right—but not the public stock price of that security. obligation—to take some action in the future. In such instances, some market analysts have argued that the generally accepted economic theory of business valuation and security analysis is flawed. Such market analysts would observe that the price DISCUSSION OF REAL OPTION at which a security changes hands is the best indica- VALUE THEORY tor of its market value. ROV theory applies option pricing theory more So, when an Internet services company goes broadly than does the typical application of finan- public at a stock price that cannot be reasonably cial option valuation (i.e., in the valuation of public explained by the present value of its expected future company or private company stock options, war- cash flow, the question arises: what is wrong with rants, grants, or rights). ROV theory is often used as generally accepted business valuation and security an investment strategic tool. analysis pricing theory? Buyers of businesses or business ownership Real option value (ROV) theory is a management interests (including equity securities) may use ROV (or investor) strategic planning tool that may be theory to justify their acquisition/investment pric- used to explain the “unreasonable” or “irrational” ing (or “overpricing”) decisions. pricing that is observed in certain situations in the The objective of this discussion is to introduce capital markets. ROV theory and to proffer ROV theory as a pos- There have always been situations where inves- sible explanation for certain capital market pricing tors have made investments at prices that cannot phenomena. www .willamette .com INSIGHTS • AUTUMN 2016 3 When acquisition/investment prices cannot be NVESTMENT ALUE VERSUS AIR rationally explained, it is not the generally accepted I V F business valuation theory or approaches that should MARKET VALUE be challenged. The concept that is really under chal- The various forms of the efficient market hypothesis lenge is the definition of economic value. Investors essentially assume the following: who pay a price greater than intrinsic value—that 1. All appropriate information is available to is, the price that is can rationally be justified by the investors. present value of expected future cash flow—may be paying what valuation analysts define as “invest- 2. Investors use that information when mak- ment value” rather than “fair market value.” ing their investment pricing decisions. That is, an “irrational” price may include com- ponents of the value that are brought to the subject The price that an investor pays for any security investment by the particular investor/buyer. investment incorporates the security holder’s right ROV theory has obvious implications to the valu- to (1) invest, (2) wait, or (3) divest. ation analyst or the transactional financial adviser: These are the “reactive” attributes of most 1. when using empirical transactional pricing financial instruments, including both publicly trad- evidence as a guideline indicator of invest- ed company and privately held company stock ment fair market value, options. 2. when advising buyers/investors in the devel- However, ROV theory also involves “proactive” opment of potential acquisition candidates, attributes of stock options, with which the security and holder actually takes action to increase the value of the option itself. 3. when pricing and structuring proposed acquisition/investment transactions. With regard to virtually any investment decision, investors have the following choices: 1. Invest now ROV theory also has obvious implications to the valuation, transactional fairness, and other invest- 2. Take preliminary steps to invest later ment analysis of: 3. Divest now 1. merger and acquisition transaction pricing; 4. Take preliminary steps to divest later 2. initial public offering pricing; 5. Do nothing 3. capital budget investment decision making; 4. capital market investment decision making; Each investment choice creates a set of eco- and nomic payoffs linked to further choices at a later 5. lost profit analysis and other economic time. This is the premise behind the proposition damages analysis related to securities fraud, that all management investment, financing, and lack of public disclosure, expropriations dividend decisions can be analyzed in terms of and condemnations, and other securities- option pricing. related litigation claims. As one may expect, the Black-Scholes option pricing model is where ROV theory conceptually begins. Table 1 Consideration of the Black- Financial Option Pricing Models versus ROV Analyses Scholes option pricing Parallels in the Component Economic Variables model helps to explain these otherwise inexplica- Black-Scholes Option Pricing Model Real Option Valuation Analysis ble “irrational” investment Economic Variables Economic Variables pricing decisions. Time to expiration Time to expiration There are direct paral- lels in the economic vari- Risk-free interest rate Risk-free interest rate ables of ROV theory and Exercise price Present value of fixed costs the six economic variables encompassed in the Black- Stock price Present value of expected cash flow Scholes option pricing for- Uncertainty of stock price movements Uncertainty of expected cash flow mula. These economic vari- able parallels are presented Dividends Value lost during decision period in Table 1. 4 INSIGHTS • AUTUMN 2016 www .willamette .com ROV theorists refer to this phenomenon as “flex- As a comparison, the holder of the financial ibility value.” This is where the “investment value” option is not in a position to influence the value of standard of value—versus the “fair market value” the security that underlies the subject option. standard of value—appears to come into play in In addition, apparently “irrational” acquisition ROV theory. prices may be explained by the application of ROV Investment value is often defined as “the value to theory. For example, these irrational prices may a particular investor based on individual investment relate to investments that are made in social media requirements and expectations.”1 companies at a significant premium over what the ROV theory seems to fit certain situations that expected net present value of future cash flow would are characterized by: indicate. 1. high levels of investment research and Corporate acquirers often expect that post- acquisition economic synergies will develop. Such 2. high levels of investment development, expected post-acquisition synergies help to ratio- manufacturing, and/or marketing. nalize the significant price premium that is paid over the expected net present value of the target For example, an investor may pay today’s “irra- company’s cash flow. tional” price for the investment—and then the Some of the recent social media company initial option buyer may use his/her influence to improve public offerings (IPOs) indicate that enough inves- the economic value of the subject investment. tors share this expected synergy explanation that this investment value may have become market value. If and when the economic benefits of the FINANCIAL OPTIONS VERSUS REAL expected synergies are not realized, these investors will presumably divest (probably selling at a more OPTIONS rational price than they bought it at). For example, as of the Tuesday, August 16, 2016, the stock market closing price of Facebook common stock was priced at $123.30. The publicly traded EAL PTION ALUE LEXIBILITY option (but not the obligation) to buy one share of R O V “F Facebook common stock before January 20, 2017, VALUE” for $110.00 per share was priced at $17.50. ROV theory encompasses both expected net present In this case, the investor of the financial option value plus “flexibility value”—the change in expect- on that day would receive a payoff of $13.30. ed net present value over the option’s life. However, that investor, having spent $17.50 on the The application of expected net present value option, would be “out of pocket” a total of $4.20. sensitivity analysis—with the best-case, worst-case, That $4.20 is the amount of the premium price and most-likely-case scenarios—does not incor- charged for the right to wait to exercise the stock porate the variance across different scenarios. purchase option—if and when the Facebook share Generally accepted sensitivity analysis procedures price increases. recognize the uncertainty with regard to economic “Real options” are not traded on organized stock outcome exists. However, such procedures do not market exchanges the way that financial options capture the “flexibility value” inherent in the situ- are. Real options are more analogous to a “valuation ation. premise.” The “flexibility value” is something that com- pany management can capture.
Load more

Recommended publications
  • Lecture 5 an Introduction to European Put Options. Moneyness
    Lecture: 5 Course: M339D/M389D - Intro to Financial Math Page: 1 of 5 University of Texas at Austin Lecture 5 An introduction to European put options. Moneyness. 5.1. Put options. A put option gives the owner the right { but not the obligation { to sell the underlying asset at a predetermined price during a predetermined time period. The seller of a put option is obligated to buy if asked. The mechanics of the European put option are the following: at time−0: (1) the contract is agreed upon between the buyer and the writer of the option, (2) the logistics of the contract are worked out (these include the underlying asset, the expiration date T and the strike price K), (3) the buyer of the option pays a premium to the writer; at time−T : the buyer of the option can choose whether he/she will sell the underlying asset for the strike price K. 5.1.1. The European put option payoff. We already went through a similar procedure with European call options, so we will just briefly repeat the mental exercise and figure out the European-put-buyer's profit. If the strike price K exceeds the final asset price S(T ), i.e., if S(T ) < K, this means that the put-option holder is able to sell the asset for a higher price than he/she would be able to in the market. In fact, in our perfectly liquid markets, he/she would be able to purchase the asset for S(T ) and immediately sell it to the put writer for the strike price K.
    [Show full text]
  • Business Valuation Courses
    The specialist in highly technical, market-driven bankingmergers and corporate & acquisitions finance trainingtraining BusinessMergers & ValuationAcquisitions Courses Courses web: redliffetraining.co.uk email: [email protected] phone: +44 (0)20 7387 4484 Advanced Negotiation Issues in M&A Date: BrochureLocation: London Content Standard Price: £*** + VAT Membership Price: £*** + VAT BOOK NOW PUBLIC COURSES Course Overview • Advanced Equity Valuation • Advanced Negotiation Issues in Financial Covenants • Advanced Negotiation Issues in M&A • Advanced Private Equity & Leverage Buy-Outs: A 5 Day Masterclass • Advanced Private Equity & LBOs Training • Advanced Takeover Code - Current Strategies & Tactics • Bank Valuation • Corporate Finance Masterclass • Corporate Finance Transactions • Equity & Debt Capital Markets • Effective Business Writing for Corporate Finance • European Term Loan “B” • How to Buy A Business • How to Sell A Business • Introduction to The Takeover Code • Joint Ventures - Key Negotiating and Structuring Issues Coursewith Content Sample Documents • Leveraged Loans in Private Equity and Corporate Transactions • Negotiating Heads of Terms (LOI/MOU) & Related Issues To book this course or find out more, please click the “Book” button Advanced Negotiation Issues in M&A Date: BrochureLocation: London Content Standard Price: £*** + VAT Membership Price: £*** + VAT BOOK NOW PUBLIC COURSES Course Overview • Tax Issues in M&A • The M&A Course • Modelling for M&A Course • Private Equity & MBO • The SPA Course - Commercial
    [Show full text]
  • Initial Public Offerings
    November 2017 Initial Public Offerings An Issuer’s Guide (US Edition) Contents INTRODUCTION 1 What Are the Potential Benefits of Conducting an IPO? 1 What Are the Potential Costs and Other Potential Downsides of Conducting an IPO? 1 Is Your Company Ready for an IPO? 2 GETTING READY 3 Are Changes Needed in the Company’s Capital Structure or Relationships with Its Key Stockholders or Other Related Parties? 3 What Is the Right Corporate Governance Structure for the Company Post-IPO? 5 Are the Company’s Existing Financial Statements Suitable? 6 Are the Company’s Pre-IPO Equity Awards Problematic? 6 How Should Investor Relations Be Handled? 7 Which Securities Exchange to List On? 8 OFFER STRUCTURE 9 Offer Size 9 Primary vs. Secondary Shares 9 Allocation—Institutional vs. Retail 9 KEY DOCUMENTS 11 Registration Statement 11 Form 8-A – Exchange Act Registration Statement 19 Underwriting Agreement 20 Lock-Up Agreements 21 Legal Opinions and Negative Assurance Letters 22 Comfort Letters 22 Engagement Letter with the Underwriters 23 KEY PARTIES 24 Issuer 24 Selling Stockholders 24 Management of the Issuer 24 Auditors 24 Underwriters 24 Legal Advisers 25 Other Parties 25 i Initial Public Offerings THE IPO PROCESS 26 Organizational or “Kick-Off” Meeting 26 The Due Diligence Review 26 Drafting Responsibility and Drafting Sessions 27 Filing with the SEC, FINRA, a Securities Exchange and the State Securities Commissions 27 SEC Review 29 Book-Building and Roadshow 30 Price Determination 30 Allocation and Settlement or Closing 31 Publicity Considerations
    [Show full text]
  • Investment Banking
    NIRMA UNIVERSITY Institute of Management Master of Business Administration (Full Time) Programme/ Integrated Bachelor of Business Administration-Master of Business Administration Programme/ Master of Business Administration (Family Business & Entrepreneurship) Programme L T PW C 3 - - 3 Course Code MFT5SEEF17 MBM5SEEF17 MFB5SEEF18 Course Title Investment Banking Course Learning Outcomes (CLO): At the end of the course, students will be able to: 1. Interpret the managing aspects and regulations affecting of Investment Banks. 2. Develop appropriate instruments keeping in view the terms of issue of security. 3. Assess the valuation aspect and issue of various kind securities. 4. Plan the restructuring including capital restructuring of a company. Syllabus Teaching Hours Unit I: Overview of Investment Banking 04 • Basic Concepts and Definitions • Role of Investment Banking as Financial Intermediaries • Business of Investment Banking • American and Indian Investment Banks Unit II: Domestic Issue Management 06 • Dynamics of primary market • Listing requirements and procedure • Raising funds through IPO • Methods of bringing out an IPO, and IPO Pricing • Due diligence process Unit III: Restructuring, Underwriting and Ancillary Services 09 • Structured products and risk management advisory • Financial Restructuring Services • Corporate Debt Restructuring (CDR) • Underwriting Services, Business Model of Underwriting, Underwriting Commissions, Devolvement and Green Shoe Option • Issuing ADR, GDR and IDRs • Arranging for Buyback and Delisting of Shares Unit IV: Investment Banking and Business Valuation 07 • Various valuation models applied in estimating value of the firm and value of equity • Merits and Limitations of each models/methods of valuation • Valuing Private Equity and Venture Finance Unit V: Issues facing Investment Banks 04 • Designing new financial instruments • Adoption of Blockchain in Investment Banks • Data Security • Other Issues Suggested Readings: 1.
    [Show full text]
  • Stock in a Closely Held Corporation:Is It a Security for Uniform Commercial Code Purposes?
    Vanderbilt Law Review Volume 42 Issue 2 Issue 2 - March 1989 Article 6 3-1989 Stock in a Closely Held Corporation:Is It a Security for Uniform Commercial Code Purposes? Tracy A. Powell Follow this and additional works at: https://scholarship.law.vanderbilt.edu/vlr Part of the Securities Law Commons Recommended Citation Tracy A. Powell, Stock in a Closely Held Corporation:Is It a Security for Uniform Commercial Code Purposes?, 42 Vanderbilt Law Review 579 (1989) Available at: https://scholarship.law.vanderbilt.edu/vlr/vol42/iss2/6 This Note is brought to you for free and open access by Scholarship@Vanderbilt Law. It has been accepted for inclusion in Vanderbilt Law Review by an authorized editor of Scholarship@Vanderbilt Law. For more information, please contact [email protected]. Stock in a Closely Held Corporation: Is It a Security for Uniform Commercial Code Purposes? I. INTRODUCTION ........................................ 579 II. JUDICIAL DECISIONS ................................... 582 A. The Blasingame Decision ......................... 582 B. Article 8 Generally .............................. 584 C. Cases Deciding Close Stock is Not a Security ...... 586 D. Cases Deciding Close Stock is a Security .......... 590 E. Problem Areas Created by a Decision that Close Stock is Not a Security .......................... 595 III. STATUTORY ANALYSIS .................................. 598 A. Statutory History ................................ 598 B. Official Comments to the U.C.C. .................. 599 1. In G eneral .................................. 599 2. Official Comments to Article 8 ................ 601 3. Interpreting the U.C.C. as a Whole ........... 603 IV. CONCLUSION .......................................... 605 I. INTRODUCTION The term security has many applications. No application, however, is more important than when an interest owned or traded is determined to be within the legal definition of security.
    [Show full text]
  • Fundamentals of Corporate Valuation
    Fundamentals of Corporate Valuation Debt free cash free company valuations: what are they? Imagine a typical company which has some amount of net debt (where net debt equals debt less cash that could be applied to refinancing that debt). Imagine too that those net liabilities could magically be removed, perhaps by a magnificent benefactor or a fairy godmother – someone who could work a wonder over the company and take away its net debt. Without those net liabilities, magically the company’s value would increase. That’s the debt free cash free valuation: the value of the company imagining it had no net debt. Shares/ equity valuation vs. debt free cash free How does debt free cash free valuation compare to shares or equity value? Let’s imagine a company that has shares/ equity with a valuation of 70 million. You can see that 70 million on the right hand side of the chart below. Let’s imagine that same company had debt less cash (= net debt) of 30 million. The debt free cash free valuation would be 100 million. That’s the value on the left hand side. Equity valuation vs. DFCF 1 Equity valuations are usually higher than DFCF values For a company that has net debt (that is, where debt is greater than cash) the debt free cash free value is higher than the shares/ equity valuation for the business. You can see that in the chart above: the 100 million on the left is higher than the 70 million on the right. Working from left to right, if the owner of a company had received a debt free cash free offer of 100 million, and if net debt was 30 million, the owner would expect to receive 70 million for the shares/ equity in the business.
    [Show full text]
  • The Promise and Peril of Real Options
    1 The Promise and Peril of Real Options Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 [email protected] 2 Abstract In recent years, practitioners and academics have made the argument that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. They have noted that these options need to be not only considered explicitly and valued, but also that the value of these options can be substantial. In fact, many investments and acquisitions that would not be justifiable otherwise will be value enhancing, if the options embedded in them are considered. In this paper, we examine the merits of this argument. While it is certainly true that there are options embedded in many actions, we consider the conditions that have to be met for these options to have value. We also develop a series of applied examples, where we attempt to value these options and consider the effect on investment, financing and valuation decisions. 3 In finance, the discounted cash flow model operates as the basic framework for most analysis. In investment analysis, for instance, the conventional view is that the net present value of a project is the measure of the value that it will add to the firm taking it. Thus, investing in a positive (negative) net present value project will increase (decrease) value. In capital structure decisions, a financing mix that minimizes the cost of capital, without impairing operating cash flows, increases firm value and is therefore viewed as the optimal mix.
    [Show full text]
  • PSU Disinvestment Valuation Guidelines
    Valuation Methodology CONTENTS CHAPTER I Introduction CHAPTER II Disinvestment Commission's Recommendations CHAPTER III Valuation Methodologies being followed Standardizing the valuation approach & CHAPTER IV methodologies CHAPTER - 1 Introduction 1.1 In any sale process, the sale will materialize only when the seller is satisfied that the price given by the buyer is not less than the value of the object being sold. Determination of that threshold amount, which the seller considers adequate, therefore, is the first pre-requisite for conducting any sale. This threshold amount is called the Reserve Price. Thus Reserve Price is the threshold amount below which the seller generally perceives any offer or bid inadequate. Reserve Price in case of sale of a company is determined by carrying out valuation of the company. In companies which are listed on the Stock Exchanges, market price of the shares serves as a good benchmark for assessing the fair value of the company, though the market price is usually characterized with significant short-term variance due to investor sentiments being influenced by short-term events and environmental aspects. More importantly, most of the PSUs are either not listed on the Stock Exchanges or command extremely limited traded float. They are, therefore, not correctly valued. Thus, deciding the worth of a PSU is indeed a challenging task. 1.2 Another point worth mentioning is that valuation of a PSU is different from establishing the price for which it can be sold. Experts are of the opinion that valuation must be differentiated from price. While the fair value of an asset is based on the assessment of intrinsic value accruing from fundamentals on a stand-alone basis, varying return expectation and underlying strategic aspects for different bidders could influence the price.
    [Show full text]
  • Straddles and Strangles to Help Manage Stock Events
    Webinar Presentation Using Straddles and Strangles to Help Manage Stock Events Presented by Trading Strategy Desk 1 Fidelity Brokerage Services LLC ("FBS"), Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917 690099.3.0 Disclosures Options’ trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options, and call 800-544- 5115 to be approved for options trading. Supporting documentation for any claims, if applicable, will be furnished upon request. Examples in this presentation do not include transaction costs (commissions, margin interest, fees) or tax implications, but they should be considered prior to entering into any transactions. The information in this presentation, including examples using actual securities and price data, is strictly for illustrative and educational purposes only and is not to be construed as an endorsement, or recommendation. 2 Disclosures (cont.) Greeks are mathematical calculations used to determine the effect of various factors on options. Active Trader Pro PlatformsSM is available to customers trading 36 times or more in a rolling 12-month period; customers who trade 120 times or more have access to Recognia anticipated events and Elliott Wave analysis. Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you're most comfortable with. As with all your investments, you must make your own determination as to whether an investment in any particular security or securities is right for you based on your investment objectives, risk tolerance, and financial situation.
    [Show full text]
  • Determining the Value of a Business
    Determining the Value of a Business August 15, 2017 @ 11 a.m. Eastern For technical assistance, contact the AT&T Helpdesk at 888-796-6118 - Thank you! We would like to thank Neal for his time and providing information regarding his experience on SBA lending programs from his perspective. All opinions, conclusions, and/or recommendations expressed herein are those of the presenter and do not necessarily reflect the views of the SBA. Advanced Business Acquisition / Appraisal Topics Presented by: Neal Patel, CBA, CVA Neal Patel, CBA, CVA Neal Patel, CBA, CVA is the Principal of Reliant Business Valuation, a business valuation and equipment appraisal firm specialized in SBA related valuations nationwide. Our firm currently works with over 150 SBA lenders around the nation. Certified Business Appraiser through the Institute of Business Appraisers (IBA) (Chair of the Board of Governors) Certified Valuation Analyst through the National Association of Certified Valuators and Analysts (NACVA). SBA/Structure Valuation Related Related Intangible Assets Cash Flow Analysis: Liquor Store Partner Buyouts Valuation Methods Stock vs. Asset Valuation Rules of Sales Thumb Other SBA Rules Price / Revenues When is a Third Party Appraisal Required? (Non Special Purpose Property) If the amount being financed (including any 7(a), 504, seller or other financing) minus the appraised value of real estate and/or equipment is greater than $250,000, or.. Note: no mention of goodwill! If there is a close relationship between the buyer and seller (for example, transactions between family members or business partners), or.. Note: employee / employer also included! If the lender’s internal policies and procedures require an independent business appraisal from a qualified source Note: every change of ownership loan requires a business appraisal ! Intangible Assets: SOP Definition SOP 50 10 5(I) pg.
    [Show full text]
  • The Importance of the Capital Structure in Credit Investments: Why Being at the Top (In Loans) Is a Better Risk Position
    Understanding the importance of the capital structure in credit investments: Why being at the top (in loans) is a better risk position Before making any investment decision, whether it’s in equity, fixed income or property it’s important to consider whether you are adequately compensated for the risks you are taking. Understanding where your investment sits in the capital structure will help you recognise the potential downside that could result in permanent loss of capital. Within a typical business there are various financing securities used to fund existing operations and growth. Most companies will use a combination of both debt and equity. The debt may come in different forms including senior secured loans and unsecured bonds, while equity typically comes as preference or ordinary shares. The exact combination of these instruments forms the company’s “capital structure”, and is usually designed to suit the underlying cash flows and assets of the business as well as investor and management risk appetites. The most fundamental aspect for debt investors in any capital structure is seniority and security in the capital structure which is reflected in the level of leverage and impacts the amount an investor should recover if a company fails to meet its financial obligations. Seniority refers to where an instrument ranks in priority of payment. Creditors (debt holders) normally have a legal right to be paid both interest and principal in priority to shareholders. Amongst creditors, “senior” creditors will be paid in priority to “junior” creditors. Security refers to a creditor’s right to take a “mortgage” or “lien” over property and other assets of a company in a default scenario.
    [Show full text]
  • SBA Procedural Notice
    SBA Procedural Notice TO: All SBA Employees and 7(a) Lenders CONTROL NO.: 5000-808534 SUBJECT: Second Extension of Notice Providing EFFECTIVE: April 14, 2021 Guidance on Underwriting 7(a) Loans during the COVID-19 Pandemic and Miscellaneous Related Matters On December 16, 2020, SBA issued SBA Procedural Notice 5000-20071,Updated Guidance on Underwriting 7(a) Loans (including Community Advantage (CA) Pilot Program loans) during the COVID-19 Pandemic and Miscellaneous Related Matters, extending through March 31, 2021 the guidance on the additional credit analysis that a 7(a) Lender should conduct and include in its credit memorandum during the COVID-19 emergency previously provided in SBA Procedural Notice 5000-20042, and extending through March 31, 2021 the guidance for certain miscellaneous matters related to 7(a) loans during the COVID-19 emergency as discussed in SBA Procedural Notice 5000-20042. Given the continuing adverse economic effects of the COVID-19 emergency, the purpose of this Notice is to extend and update the underwriting guidance and the guidance on certain miscellaneous related matters through June 30, 2021 and provide additional updates as described below as a result of the enactment of the Economic Aid Act on December 27, 2020. A. Updated Underwriting Criteria for New 7(a) Loans Made During the COVID-19 Emergency: Lenders must analyze each application in a commercially reasonable manner, consistent with prudent lending standards, and must demonstrate that the cash flow of the applicant is the primary source of repayment, not any expected recovery from the liquidation of collateral. Further, SOP 50 10 6, Part 1, Section A, Ch.
    [Show full text]