The Ways Business Loans Impact Company Valuations 

Business loans do not directly impact a company’s valuation, but they can indirectly help or hurt depending on how the borrowed money affects profits, cash flow, and the level of financial risk buyers see in the business. 

When it’s time to sell your company, buyers typically value it based on its ability to generate profits and future cash flow. If borrowed money increases those profits, it can increase the value of the business. If the debt reduces cash flow or adds risk without increasing profits, it can hurt the business or reduce what you take home when you sell. 

Before getting into how business loans can influence the ultimate valuation of your company, it’s important to understand the difference between your company valuation and how much you’ll take home if you sell. 

What goes into a business valuation 

Buyers determine the total value of your business, sometimes called “enterprise value,” using: 

• Your company’s financial performance. 

• Industry specific conditions and growth potential. 

• How many buyers are currently looking for businesses like yours. 

Faster growing companies get higher valuations than low growth ones as there is an expected larger growth in future cash flow. Industries where there is no innovation or that are at risk of being disrupted by new technology have lower valued businesses because investors assume cash flow growth is limited. Market timing also matters — when more buyers compete for a limited supply of businesses, demand drives valuations higher. 

To get a quick estimate for your own business’s valuation, multiply your company’s earnings by a market multiple: 

Enterprise value = Earnings before interest, taxes, depreciation, and amortization (EBITDA) * market multiple. 

Market multiples are for companies similar to yours in size, growth rate, industry, and other financial measures. They also change depending on economic conditions and the demand from buyers for your type of business. If businesses comparable to yours sell for market multiples of 3 and your EBITDA last year was $5 million, your enterprise value estimate would be: 

EV = 3 * $5M = $15 million. 

Look for businesses similar to yours and contact their brokers to get a sense of what multiples the market is paying. Once you have the multiple, multiply it by your EBITDA and you have a good estimate for your total business value. 

Note: The EBITDA multiple method is a common and useful starting point, but businesses in asset-heavy industries, early-stage companies, or distressed situations may be valued using different approaches, such as asset-based or revenue multiples. 

While enterprise value is your business valuation, “equity value” is what you receive from the sale after debts are settled, calculated with this simplified formula: 

Equity value = Enterprise value − Total Debt + Cash 

Note: This is a simplified formula. A full calculation may also subtract other debt-like obligations such as minority interest, preferred stock, or unfunded pension liabilities depending on the deal structure. Additionally, transaction costs, taxes, escrow holdbacks, and earnouts will further reduce your actual take-home amount. 

Taking your $15M enterprise value from earlier, if you have $1 million in debt on the books and $400,000 in cash, your equity value would be: 

Equity value = $15M − $1M + $400K = $14,400,000. 

When you think about taking a new business loan or whether you should pay one off before selling your company, equity value is what matters to your bank account at the end of the day. And this is where your business loan can impact the buyer and the price they’re willing to pay. Here are 3 common scenarios and how business loans fit into what you may want to do. 

Taking new debt before selling 

Taking on new debt before selling can improve company valuations when it helps grow your business with a positive return on the investment. Wisely investing money from the loan creates growth for more sales that translate to higher EBITDA. This increased growth rate may also attract more buyers and increase the multiple you’re able to get. 

Here’s how this combination results in a higher company valuation for you. If you borrow $200,000 from an equipment financing loan so that you can take larger contracts, it increases EBITDA by $100,000 per year. When doing your research you find that similar businesses sell for a 3x multiple. 

The increased business valuation comes from a combination of higher EBITDA multiplied by the market multiple using this formula: 

Additional enterprise value = additional EBITDA * market multiple Additional enterprise value = $100K * 3 = $300,000. 

That raises your enterprise value by $300K, but it only increases the money you take home if it also increases your equity value with this formula: 

Added equity value = added enterprise value − added debt. 

Since you added $300K in enterprise value and the loan was $200K, you keep an additional $100K in equity value after paying back the debt. 

Paying off a loan before selling 

Paying off a loan before selling normally does not change how much you receive from the sale and it can hurt your enterprise value if you sell off productive assets (investments and production machinery) or anything that cuts too deeply into cash. 

When you pay off debt with cash, both assets and liabilities decrease by the same amount. Since there’s no immediate impact to EBITDA it doesn’t affect your enterprise value. Sticking with the example from earlier you had: 

• $5M EBITDA 

• 3x market multiple 

• $1M debt 

• $400K cash 

If you use the cash to pay down debt then you would have: 

• $5M EBITDA 

• 3x market multiple 

• $600K debt 

Enterprise value is EBITDA * market multiple and it’s the same whether you use cash to pay debt or not. 

This creates a problem if cash is reduced too much, causing you to miss payroll, pay late on invoices, or miss a payment on other types of business loans that could trigger a default. Potential buyers for your business talk to employees and hearing that you missed payroll payments is a big red flag, same as suppliers saying that you were late on invoices. 

Lenders and suppliers may report late and missed payments to the business credit bureaus, which hurts your business credit score. This signals risk to buyers and they might pass on making an offer or give you a lower multiple. 

If you don’t pay off the loan and leave cash in the bank, whoever buys your company may refinance the debt, replace it with their own financing, or pay it off as part of the transaction depending on their strategy for the deal. 

Taking investor money to pay down debt 

Taking money from an investor to pay down debt usually does not increase your company’s valuation by itself because it does not increase profits or future cash flows. It mainly changes the structure of your balance sheet by replacing debt with equity in the standard balance sheet equation: 

Assets = Liabilities + Owners’ Equity 

Here’s what happens if you have $500,000 in debt, your current enterprise value is $5,000,000, and you sell a 10% equity stake to pay down debt: 

• The $500K investment increases owners’ equity. 

• Assets (cash) increase by $500K. 

The balance sheet equation looks like this: 

Assets (+$500K) = Liabilities (no change) + Equity (+$500K) 

When you pay off the loan, assets (cash) drop by $500K, liabilities (the business loan) drop by $500K, and the equation remains balanced as follows: 

Assets (−$500K) = Liabilities (−$500K) + Equity (no change) 

This is similar to the last section where changes to the balance sheet don’t immediately impact EBITDA. Because EBITDA didn’t change, neither does your estimated enterprise value. A strategic financing choice like this still makes sense if removing the debt frees up cash flow that you reinvest in profitable growth. 

Here’s how your equity value increases by using investor money to pay down debt in a hypothetical scenario with these details: 

• Your market multiple moves from 2x to 2.5x because you grow EBITDA by $200K after reinvesting $100,000 that you saved from interest expense after paying down the loan. 

• Your starting EBITDA is $2.5 million. 

• Starting equity value (assuming 100% ownership) = starting EBITDA * starting multiple − starting debt + starting cash $2.5M * 2 − $500K + $0 = $4,500,000 

• Ending equity value = (ending EBITDA * ending multiple − ending debt + ending cash) * ending ownership share ($2.7M * 2.5 − $0 + $0) * 90% = $6,075,000 

The increased value doesn’t come directly from paying down the debt. It comes from reinvesting the money you save on interest expense to grow EBITDA, which then helps you get a higher multiple. This combination gives you a higher enterprise value so even though you sold 10% to the investor, your equity value increased from $4.5 million to just over $6 million. 

Business loans don’t impact company valuations directly, but how you invest the money and whether it creates a positive return on investment does. As long as the return generated by investing a loan is greater than the cost of the loan, it can create growth that helps to increase your enterprise value and attract a higher market multiple from buyers. Before making any pre-sale financing decisions, consider consulting a financial advisor or M&A professional to evaluate how each option affects your specific situation. 

SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.