Have you ever wondered about the value of your business? How is that value determined?

In today’s landscape, business owners must clearly understand the value of their businesses. Why? Because this knowledge serves as the starting point for critical decisions regarding estate planning, transactions, financing, employee compensation, stock transfers, and even litigation support.

We created an overview of the valuation process and explored how it can benefit you in various scenarios. Whether you're a company owner, an executive, or an advisor, this guide will shed light on the intricacies of business valuation and the steps involved.

Why is a Business Valuation Needed?

Before delving into the process, let's clarify why a business valuation is necessary. A business valuation provides a business owner with an assessment of several key valuation drivers. These insights can be used as a basis for significant management planning decisions and certain key business milestones:

Estate & Gift Planning

Understanding the value of your business is vital for estate planning and making informed decisions regarding the transfer of ownership or gifting interests.

Merger & Acquisition Transaction

If you are buying or selling, knowing the accurate value of a business helps in negotiations, deal structuring, and determining fair prices.

Bank Financing

Banks often require a business valuation to assess the collateral value and determine the loan amount for US Small Business Administration (SBA 7a) financing.

Employee Stock Compensation

Valuations assist in establishing the value of stock options or restricted stock units (RSUs) offered as compensation to employees.

Buy/Sell or Other Stock Transfer Provisions

When internally buying or selling shares or transferring stock ownership, a business valuation establishes a fair price and protects the interests of all parties involved.

Litigation Support

When dealing with legal issues like marital dissolution, economic damages, or shareholder disputes, valuations play a crucial role in legal proceedings by providing expert opinions on the value of a company and its assets.

General Valuation Approaches

To arrive at a comprehensive business valuation, professionals employ three general valuation approaches:

Asset Approach

This approach determines the value of a business based on the value of its adjusted assets net of adjusted liabilities. By carefully assessing the company's assets, including property, equipment, inventory, intellectual property, and goodwill, among others, valuation experts can arrive at an objective estimate of the business's value. The asset approach is particularly relevant for businesses with substantial tangible assets or when the company's value is closely tied to its asset base.

Market Approach

The market approach relies on market-based indicators to determine the value of a business. It considers the prevailing market conditions and compares the subject to similar companies recently sold or publicly traded. By analyzing key financial metrics, market multiples, and transaction data of comparable companies, valuation professionals can assess the relative value of the business in question. The market approach offers a practical and objective perspective on the business's value, considering market perceptions and investor expectations.

Income Approach

This approach focuses on estimating the value of a business based on its expected future income generation. Valuation experts can gauge the business's intrinsic value based on its ability to generate sustainable earnings. This approach is particularly relevant for companies with stable cash flows and predictable revenues.

Steps in the Business Valuation Process

Now that we understand why business valuation is important and the three approaches used, let's explore the steps involved in the valuation process:

Initial Meeting

The process begins with an initial meeting to determine the type of valuation needed. During this meeting, the advisor will gather information about the valuation’s purpose, the key valuation drivers, and any specific requirements.

Collection of Data and Documents

In this stage, relevant data and documents are collected to gain a comprehensive understanding of the business's operations and financials. This may include:

• A brief history of the company with biographies of key employees
• Description of the competition and market dynamics
• Organizational documents (articles of corporation, by-laws, operating agreement, buy-sell agreement, etc.)
• Financial statements from the last 3-5 years
• Budget or projection for the next 2-3 years
• Current depreciation schedule
• The fair market value of assets, such as real estate or machinery, supported by appraisals (if available)

Report Preparation

The valuation professional prepares a comprehensive report based on the collected data and analysis. The report outlines the methods employed, critical assumptions made, and the determined value of the business. It may also include a discussion of the key drivers positively or negatively impacting the valuation.

Report Delivery

The final step involves delivering the valuation report to the client. Alongside the report, they may offer consulting services to help the client understand the valuation results, identify opportunities for value enhancement, and address any concerns or questions.

Understanding the business valuation process is essential for business owners navigating complex decisions related to their organizations. If you have any questions or require further assistance with the business valuation process, please contact the Lutz M&A team.