Many Maine-based small business owners know some of the theory behind business valuation, but they might not know all of the procedures involved in the analysis and preparation of a report. Clients and attorneys who understand how the valuation process works are better equipped to anticipate their experts’ needs and appreciate why valuators need to look at so many documents and ask so many questions. Valuation isn’t an overnight process that can be done remotely. It’s hands-on and intensive.
To help explain the process, here are the five basic steps taken by business valuation professionals:
1. Pre-Engagement Stage. This is the beginning step where sufficient information is gathered to determine the scope of work needed to complete a competent valuation. Usually this involves a review of financial statements and tax records, as well as a discussion with the business owner. The valuator uses this information to prepare their fee.
A critical part of this step is a clear and specific definition of the valuation assignment. This definition ensures that all the parties are on the same page from the get-go. Misunderstandings that go unchecked can lead to re-work or embarrassing revelations in court.
The definition may include the name of the business, the type of business entity, the basis and standard of value, and the purpose of the valuation.
2. Information Gathering Stage. In the next step, the valuator begins to gather information in order to acquire an understanding of the company and its management, products or services, market, competition, and industry. The information could come from documents, site visits, and management interviews. The valuator will also get industry information from trade associations and/or government sources and commercial providers.
3. Financial Analysis Stage. Next, the valuator begins the analysis by adjusting the financial statements to better reflect economic reality in a process called normalizing. Normalized statements are compared to industry statistics. Financial ratios are calculated, and trends are analyzed. The company’s financial strengths and weaknesses are identified. Any projections of future results must be reviewed to see if the underlying assumptions are reasonable.
4. Valuation Method Stage. There are three different approaches to determine value. Appraisers consider various methods within each one to decide which are the most appropriate.
- Asset-based approach. Value is determined by subtracting the company’s liabilities from its assets.
- Market approach. Value is derived from comparable public stock prices or sales of entire comparable business
- Income approach. Value is based on future earnings or cash flows, which are discounted to their net present value based on the business interest’s required rate of return.
After evaluating the different methods, the valuator determines which are most appropriate and uses one (or more) to reach a conclusion. In some cases, valuation discounts may also apply, depending on the methodology used and the desired basis of value.
5. Report Writing Stage. The final step is presenting the report to the client. Communicating all of this information in writing so that it clearly explains the expert’s findings, procedures and conclusions can be a challenging part of the valuation process. The professional should be able to verbally explain the report and answer any questions
Performing a business valuation involves more than plugging numbers into valuation software and printing out the results. It is a complicated, time-consuming process that involves multiple steps. Clients and attorneys who understand the process help facilitate it. Filler & Associates are experts in the field of valuation and can explain the process further.