What are the Steps of the Business Valuation Process?
1. Understand the Client’s Needs
How do you end up with a perfect product or service? It starts with a perfect purchase order. What are the client and their advisors trying to accomplish? Is this valuation so the business can go to market or is it for the courts or the IRS? Knowing the final audience and who might attack the valuation is that critical first step.
2. Create a Proposal & Engagement Letter
After understanding the purpose, audience, and stakeholders involved, then the engagement letter can be created to cement everyone being on the same page. Many times putting step one to paper changes what the stakeholders thought were their needs. There may also be Assumptions and Limiting Conditions. These are the parameters and boundaries under which a valuation is performed, as agreed upon by the valuation analyst and the client or as acknowledged or understood by the valuation analyst and the client as being due to existing circumstances. An example is acceptance, without further verification, by the valuation analyst from the client of the client’s financial statements and related information.
3. Establish the Standard of Value, Purpose, & Valuation Date
Taking all of the above into account, the applicable standard of value must be specified and defined to provide the basis for any appraisal report or engagement. The selection of the applicable standard of value is determined largely based on the use to which the appraisal is to be put, such as determination of a tax liability or determination of a price at which a particular transaction will take place.
Often the standard of value for a particular appraisal engagement is dictated by statute, regulation, case law precedent, or a binding legal document governing a transaction. It is important to recognize that many value terms have different definitions when used in different contexts. It is essential that the appropriate standard of value is defined and that the approaches and methodology employed conform to the defined standard of value.
Valuation date refers to a point in time in which an asset is assigned a dollar value. It is a term often used in reference to the valuation of assets to be distributed upon the occurrence of an event, or a periodic determination of worth for reporting purposes. For example, it may be the designated time of closing (monthly, quarterly, etc.) for the determination of account balances in a defined-contribution or defined benefit plan. The general rule will be that a court will most strongly consider the value at the date of distribution.
By having within its discretionary power the ability to determine the valuation dates, the court has another tool in which to bring equity to asset distribution. For example, in a divorce matter, the court may be trying to determine how to distribute assets such as a family home or securities, commercial real estate or business goodwill. State law varies on when the valuation date is in a divorce case. Most often, states use either the trial date, the date of final separation, or date of divorce complaint as the valuation date. However, the date may be discretionary in some states. Local laws should be consulted for specific requirements in your area.
4. Gather Data
Business Appraisal Florida has a business valuation checklist that can be used to pre-gather the data. The faster you get the data to us the faster we can generate a draft valuation. Once you know how and under what conditions a business’s worth will be measured, it is time to gather the relevant data that impacts the business value. This data may include the business financial statements, operational procedures, marketing and business plans, customer and vendor information, and staff records. The quality and timeliness of the data is also a variable.
5. Tax Return/Financial Statement Analysis & Ratio’s
Businesses are required to file federal tax returns on an annual basis. The information contained in these tax returns can be used to determine the business’s financial strengths and weaknesses. Lenders often perform a detailed analysis of a business’s tax returns to assess the risk associated with lending. The analysis involves examining the tax return and calculating financial ratios from tax return numbers. Comparisons are often made to other businesses in the same industry to ascertain the business’s performance according to industry benchmarks.
6. Normalize and Adjust (if applicable) Historical Financials
What are normalized adjustments to the Income Statement? The “normal” return of a private company cannot be compared to those of a public company unless certain adjustments are made to the income statement. Everything from the owner’s compensation to market rents needs to be reviewed and possibly adjusted. These adjustments are made so income streams can be compared to that of a freely traded stock or ownership interest. Also, in privately held companies, many times one-time adjustments need to be made for non-operating expenses or other one-time events.
7. Company, Industry & Peer Analysis
How your company compares to its peers is a critical variable in the valuation process. Also, industries go in and out of favor causing earnings multiples to be constantly expanding and contracting. Your company’s size versus its peers will also affect the valuation. Comparable company analysis starts with establishing a peer group consisting of similar companies of similar size in the same industry or region. Investors are then able to compare a company to its competitors on a relative basis.
8. Implement Selected Valuation Methods
In developing the valuation, the valuation analyst should consider the three most common valuation approaches:
1. Income (income-based) approach
2. Asset (asset-based) approach (used for businesses, business ownership interests, and securities) or cost approach (used for intangible assets)
3. Market (market-based) approach
The valuation analyst should use the valuation approaches and methods that are appropriate for the valuation engagement. Many times numerous valuation approaches are used and the appropriate one(s) are selected with the reason for that selection given.
9. Generate Draft Report
Many times on issuing a draft report, the lightbulb will go off in at least one of the party’s heads as what the expected will be compared to the reality of the valuation given the parameters and constraining conditions.
10. All Parties Review Draft Business Valuation for Accuracy
Your CPA, attorney, partners or other stakeholders need to understand the valuation and make sure all terms and adjustments pass the reality test.
11. Issue Final Report
A Valuation Time Frame (client-driven) can range from 2-6 weeks. The faster you get us the data, the faster you get a professional business valuation.