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Valuing a business accurately is essential for making informed decisions, whether you’re buying, selling, or assessing your company’s worth. Here are the ten essential steps to conduct a business valuation:

1. Engage a Business Valuation Professional

Engaging the services of a business valuation professional is crucial. Their expertise is vital in making the right judgment calls, as every company is unique and the circumstances surrounding each valuation differ. A seasoned business appraiser brings critical experience to the task, ensuring the valuation is both accurate and defensible.

2. Understand the Purpose of the Valuation

The purpose of the valuation dictates the standard of value, the valuation approach, and the assumptions made in calculating value. Whether it’s for a sale, merger, or legal requirement, understanding the purpose is fundamental to a business valuation.

3. Determine the Basis of Value

Consider the type of value being measured and the perspectives of the parties involved. Is the value based on the transaction price between a willing seller and buyer, or the investment value to the current owner? The basis of value is often stipulated by regulation, law, or contract and is a key factor in a business valuation.

4. Determine the Premise of Value

The premise of value depends on the purpose and basis of the valuation. It could be a going concern premise, assuming the business will continue operating, or an orderly/forced liquidation premise, assuming the sale of assets individually or in a group. In mergers and acquisitions, the premise might be higher due to the benefits realized by the purchaser.

5. Gather Relevant Data

Collecting comprehensive data is essential for a business valuation. This includes financial records, contracts, customer and supplier agreements, leases, loans, and other obligations impacting future profitability. A business valuation checklist can help compile the necessary information. Additionally, comparing similar companies’ financial performance provides valuable insights.

6. Review the Historic Performance of the Business

Understanding the company’s history, ownership structure, and past financial performance is critical. Comparing the business to similar companies in the same industry helps establish its relative performance. Metrics like price-to-earnings ratios, price-to-book values, and price-to-free cash flow are used in this comparison.

7. Determine the Future Outlook for the Business

Future value is derived from the prospect of future cash flows. This involves forecasting future revenues, operating expenses, taxes, capital requirements, cost of capital, and market share. A business plan valuation is essential to assess management’s plan for ongoing value creation. The experience of a valuation professional is invaluable in making these projections.

8. Determine the Valuation Approach to Use

Selecting the appropriate valuation approach depends on the purpose, basis, and premise of value, and the availability of relevant data. The three basic approaches are the market, income, and cost approaches. Often, multiple approaches are used, and their values are averaged to produce a defensible business valuation.

9. Apply Discounts

For private companies, discounts for lack of marketability and lack of control are applied. These discounts account for the inability to quickly convert ownership stakes to cash and the lack of control over key decisions. In some cases, a key man discount may also apply, reflecting the value associated with an important individual like the founder.

10. Arrive at a Determination of Value

The final step is reaching a conclusion of value, supported by a comprehensive valuation report. This report details the information, valuation approaches, and assumptions used, establishing the defensibility of the business valuation.

By following these ten steps, you can conduct a thorough and accurate business valuation, providing a solid foundation for informed decision-making.

Read more at Insight Advisory Group.

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