Documents Needed for Business Valuation Checklist

Brad Nakase, Attorney

Email  |  Tel (888) 600-8654

Determining Your Business Market Value

Johnny, a born-and-raised mechanic, has owned a garage in Los Angeles for the last ten years. Because of his expertise in fixing cars, Johnny has enjoyed a successful decade in business, and his company has earned an impressive profit during that time. He has also earned a reputation that has made him popular in the local community. However, Johnny is ready for retirement. He plans to sell his business and use the profits of that sale to buy a lake house. However, Johnny is not sure how to determine his business’ market value. Obviously, Johnny thinks of his beloved garage as priceless. However, he knows that a business’s market value must be considered objectively. That said, he doesn’t know how to evaluate his revenue and assets. He knows that he has valuable equipment which would interest potential buyers. He knows that he must make the business seem like an attractive purchase while still getting a fair price. Johnny wonders how to go about determining a fair market value to ensure that the deal is fair for all involved.

What is the Purpose of Valuing a Business?

Estimating the value of a company serves a number of purposes in the business world. Whether it is raising a round of funding, applying for a small business loan, or transferring ownership of the company, a small business will experience different financing events in its lifetime. All of these events require an estimation of the company’s value in order to proceed. For businesses both new and old, it is valuable for an owner to know the value of the business as soon as possible. Having an idea of value and feeling confident in that number will help an owner convince investors and raise funding for the business. Knowing the value of one’s company can also help an owner price the company to find the right buyer, if the goal is to sell the business.

A valuation is an estimation of a company’s total worth. There is a specific formula used to calculate a business’ value. This formula considers assets, earnings, the industry, as well as debts and losses. Businesspeople interested in buying an existing business should be educated on valuations so that they feel at ease estimating a business value independently. He or she should not have to rely on the business owner’s word or the broker’s asking price.

For those who are new to buying and selling businesses, there are many online resources that can help figure out the value of a business. Even if a business owner is not planning to sell his or her business, being aware of how to value a business, including one’s own, can help a company plan for the future. It can also help provide exit strategies.

Performing a valuation of one’s company is a great way of studying the business’ financial health and potential for growth. The same can be said of a business one is planning to buy. Valuing a business requires an entrepreneur to do financial inquiry and to keep a clam head and steady emotions. If this is an individual’s first company, or if it is a family-owned or run business, then a valuation should be as objective as possible to result in a fair and accurate number.

Documents Needed for a Business Valuation

The documents needed for a business valuation are as follows:

  • Financial Statements (Balance Sheet, Profit & Loss Statement) (Important)
  • Account payable and Account receivable with ageing report
  • Tax Returns (Important)
  • Pending litigation if any (Important)
  • Investments
  • Corporate bylaws, article of incorporation, board meeting minutes, stock ledger
  • Business plans
  • Lease(s)
  • List of Intellectual Capital
  • Business Forecasts and Projections (If available)
  • Business Plans and Organization Documents (If available)
  • Payroll
  • Loan documents
  • Fixed asset with depreciation
  • Inventory reports

How to Understand a Business Valuation

The process of valuing a business is not easy unless perhaps one is an accountant or a natural numbers person. In order to conduct an accurate valuation, there are a few definitions to understand first:

Seller’s Discretionary Earnings

Seller’s discretionary earnings, or SDE, is similar to EBITDA. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. This is essentially the pure net proft of a business.

Business owners calculate SDE to determine the true value of the business for a new owner, similar to what EBITDA does. SDE will include certain expenses such as the income one reports to the IRS and non-cash expenses. All the revenue the business brings in is included, basically. However, unlike EBITDA, the evaluator will also add in the owner’s salary and benefits into the SDE calculation. Typically, large businesses will use EBITDA calculations to value their businesses while small businesses will use SDE. This is because small business owners usually expense personal benefits.

It is important that potential buyers understand SDE, not only business owners. This is because it is likely that a business owner will provide a number for the buyer. It is critical that the buyer understand how the owner arrived at that value, as well as what those numbers say about the business.

To calculate a business’ SDE, one should start with the pretax, pre-interest earnings. After, one will add back any purchases that are not considered essential to operations. These might include vehicles and travel, which will be reported as business expenses. Employee outings, one-time-purchases, charitable donations, and the owner’s salary will all be included in the SDE. It is important to know that buyers may ask about discretionary cash flow, which means one should be prepared to include and value every major expense and purchase.

Any current debts and future payments, known as liabilities, should be subtracted from the net income.

SDE Multiples

SDE indicates the true, monetary value of a business. However, an SDE multiple values a business according to industry standards. If an owner uses EBITDA to value his or her business, then he or she will use an EBITDA multiple. In general, small businesses should use SDE to perform business valuations, because small business owners typically take a big percentage of their business’ revenue to cover their salary and living expenses.

For every industry there is a different industry multiple. A particular business’ SDE multiple will depend on how a market shifts, the location of the business, the business’ size, its assets, and how much risk is involved in the transfer of ownership. The higher an SDE multiple, the more a business is worth.

How to Organize Finances for Valuing a Business

The process for figuring out the value of a small business is complex, and because of this, a business owner or buyer may wish to consider hiring a professional business broker or accountant. These individuals specialize in performing valuations, and it is easier to rely on their insight than trying to do the evaluation on one’s own. That said, an individual is still perfectly capable of valuing a business on their own with the right resources. However, the first step is to get one’s financial information organized.

Before valuing a small business, both buyers and sellers should organize their financial records so that calculations will be accurate. Also, in addition to doing the valuation, having organized finances is crucial in order to transfer the ownership of a business.

Sellers will need to have the following paperwork organized to make the valuation process as smooth and easy as possible:

  • Deeds, licenses, and proprietary documents
  • Profit and loss statements for the previous three years
  • Tax returns and filings
  • Brief overview of business or personal finances

Regarding the tax returns, it is important to note that purchases which were reported to the IRS as business expenses should be added back to earnings when calculating the SDE. These expenses include travel expenses, personal vehicles, and other one-time non-essential purchases.

While buyers do not need to provide all these documents, it is still wise for them to review their own financial information and make sure that it is in order. This is because sellers will want to see a buyer’s credit report and financial profile.

Having a strong, organized financial foundation helps an owner or a seller to keep a realistic view of the company and its value. The more an individual focuses on this step of the valuation process, the more confident he or she will go into the calculations phase.

How to Take Stock of a Business’ Assets for Valuation

It can seem like an impossible task to determine the value of a whole business and reduce it to a single number. But it is important to remember that this number is just an estimate. A seller needs to put a number on their business if he or she wishes to be paid for all their hard work. All kinds of equity should be taken into account.

A business owner should come up with a list of the property, production, and resources that make up the business. This would also include assets, liabilities, cash, investments, employees, and intellectual property. This list will come in handy later when one creates an overview of the company for prospective buyers. If a buyer is intimidated by this part of the process, there is no harm in seeking the help of a professional advisor, who can help assess the business’ assets with an objective point of view.

To correctly take stock of one’s assets, a seller will need to follow a series of steps. The first of these steps is to create a detailed report of business assets and liabilities. Business assets include anything that adds value to the company. These things might include intellectual property, a production line, delivery truck, or equipment. Anything that is part of the business will need to be included on the list as an asset or liability. When it comes to assets, there are two categories that are given different weight when calculating the value of a business. These categories are:

Tangible Assets

Tangible assets are a company’s material resources and holdings. Some examples of these assets include:

  • Real estate and property
  • Equipment and means of production
  • Inventory and stock
  • Cash on hand

Intangible Assets

Intangible assets are the non-material assets that add value to a business. These are a critical part of an SDE multiple. Therefore, it is necessary to identify these assets and write down their estimated value. Intangible assets might include the following:

  • Patents, trademarks, copyrights
  • Intellectual property
  • Brand and reputation
  • Customer base and loyalty

How a Business’ Liabilities Factor into Valuation

It is important for a business owner to be aware of his or her business liabilities. Liabilities may include debt and outstanding credit on the business’ books. These debts reduce the total value of the business. This is the reason this number is subtracted from the SDE when value is calculated. In general, sellers choose to keep their business liabilities and pay off their debt after the sale of the business.

A business’ relevant liabilities may include the following:

  • Notes payable
  • Business loans
  • Accounts payable
  • Accrued expenses
  • Debts and payables
  • Unearned revenue

Is It Necessary to Create a Business Plan and Model for Valuation?

After reviewing a business’ assets and liabilities, the next step in performing a valuation is creating a business plan and model. If an individual is selling his or her business, he or she should make it clear to any buyers how the business makes money. It should also be clear how the business will continue to make money in the future, to attract buyers.

Why Is a Business Plan Important for Valuation?

Creating a business plan can help business owners accurately predict revenue and market growth. It is an important way of showing prospective buyers that the business will continue to succeed and grow. A strong business plan provides buyers with context, such as location, purpose, and mission. It also details the major services or products that the company offers.

Why Is a Business Model Important for Valuation?

A business model shows that a business can bring in money. This applies to subscription-based businesses, direct-to-consumer e-commerce, and B2B consulting. While a valuation is just an estimation, a business model offers buyers a vision of how they can reach a customer base and make money should they purchase the company.

However, this step in the process does not only apply to sellers. Buyers interested in acquiring a company should make a list of the target business’ assets and liabilities. This keeps emotion out of the buying process, ensuring the decision is based on facts and sound financial judgment. It is important that the buyer and seller agree on the valuation. A buyer should keep an eye out for business plans that outline processes clearly and display good, reliable management. It is much easier to transfer ownership of a well-run business. This ensures that profits are maintained and the process is much easier to manage.

How to Research an Industry for Valuation of a Business

For both buyers and sellers, it is essential to be familiar with the industry in which a business operates. Buyers should not make an offer on a business before becoming knowledgeable on that business’ industry. The more expertise, the better. For sellers, it is equally important to understand their industry’s trends in order to make an accurate valuation. This valuation should reflect a business’ assets and the current market.

A business’ SDE multiple, as well as the valuation method, may vary depending on certain factors. One of these factors is the strength of the industry in which the business operates. It is the duty of the seller to learn all they can about companies similar in size, model, and revenue. These similar businesses are known as comparables, or comps. They can give a businessperson an idea of how a company fits within the market and provides insight about the sector in general. Understanding similar companies can help a businessperson evaluate a company’s market share and ability to grow. Using this method, a seller will be able to show potential buyers what makes his or her business special.

Annual and quarterly reports for public companies are usually available to review online. It may also be possible, depending on corporate transparency, to see what similar businesses are selling for. Buyers interested in the internet and tech industry can look at online directories like Crunchbase and AngelList to find information about startups, investors, funding, and more topics.

What Are Different Methods to Perform a Small Business Valuation?

There are three business valuations techniques that buyers and sellers should understand in order to perform an accurate small business valuation. These approaches use different variables of a business to calculate the value in the form of a number. These variables include a business’ income, assets, or market data based on similar companies.

A valuation should be based on consistent calculations, so it is important not to mix valuation formulas or methods. However, it is perfectly acceptable to try different formulas separately to compare results. If numbers do not seem right, one should not be afraid to investigate why this is or contact an accountant for assistance.

What Is the Income Approach to Valuation?

The income method used to evaluate a business figures out the amount of income a business may be expected to earn in the future. Taking this approach means picking between two sub-methods:

Discounted Cash Flow Method

The discounted cash flow method of valuation figures out the current value of a business’ future income. The business’ cash-flow prediction is adjusted depending on the risk involved in the purchase of the business. This method is best for newer businesses with a lot of growth potential but that are not yet profitable.

Capitalization of Earnings Method

The capitalization of earnings method of valuation figures out a business’ future profitability. This calculation considers the business’ cash flow, annual rate of return (ROI), and its expected value. Unlike the discounted cash flow method, which takes potential changes into account, the capitalization earnings method assumes that calculations for a moment in time will continue going forward. Therefore, this method is best for established businesses that enjoy a stable profit.

It is useful to know that the majority of online business valuation calculators use the income approach. However, if a buyer or seller has additional financial information available, then it may be better to use a tool that studies profit, revenue, assets, and liability. This results in a more comprehensive analysis.

What Is the Asset-Driven Approach to Valuation?

The asset-driven approach determines the value of a business by looking solely at its assets. The Adjusted Net Asset Method will figure out the difference between a business’ assets (equipment, inventory, property, intellectual property) and its liabilities. Both values are adjusted to reflect fair market values. Asset valuations are a valuable tool for internal analysis as they can help an owner monitor spending and resources.

To perform an asset-driven evaluation, an owner will need to make a list of the business’ assets and give them a monetary value. For depreciating assets such as equipment, the value is typically somewhere between the sale price and the depreciated value. It is often a good idea to estimate how much a piece of equipment would sell for today. This is the number one should use.

As a business owner is usually familiar with his or her own equipment and production line, he or she can come up with accurate estimates of an asset’s value and depreciation. If an owner fails to adjust the asset’s worth in line with the current market, it is still possible to have a good idea of the business’ material value. This method of valuation is useful for businesses that mainly hold investments or real estate, is not profitable, or is hoping to liquidate. For businesses in these situations, buyers will want to know the value of investments and equipment.

What Is the Market Approach to Valuation?

The market approach to valuing a business figures out a company’s value based on the purchases and sales of similar companies in the industry. Therefore, this approach can help a buyer or seller decide on an appropriate price based on the local market. So long as a business collects enough relevant data on the market, then any business can use this approach to business valuation. However, it may be an especially helpful approach for businesses that are growing at a rapid pace.

Please tell us your story:

4 + 3 = ?

What Is a Gap Analysis

What is a Gap analysis?

Gap analysis helps businesses compare current performance with desired goals, identifying inefficiencies. This method aids in developing action plans to bridge performance gaps.
SWOT Analysis Example

SWOT Analysis Example

Conducting an HR SWOT analysis helps identify strengths, weaknesses, opportunities, and threats within and external to an organization. This process aids in developing strategic HR actions aligned with the company's objectives.

Costco Hot Dog Price Story

The story about Costco $1.50 hot dog price began in 1993 when the Costco merged with Price Club. Costco's $1.50 hot dog price remains unchanged in 2024.

Request for Production of Documents, RPOD, CCP 2031.280

Starting January 1, 2020, California's civil litigants face stricter discovery rules under Cal. Civ. Pro. § 2031.280(a). All produced documents must now be labeled by request number, impacting both new and ongoing cases.
What is a default judgment

What is a default judgment

A default judgment is issued when a defendant fails to respond to a lawsuit, allowing the plaintiff to win by default. Understanding this process is crucial for both parties involved in litigation.
What is a quitclaim deed

What is a quitclaim deed

Quitclaim deeds offer a quick way to transfer property ownership without guarantees, distinct from warranty deeds. Ideal for non-sale property transfers among family or into trusts, they require careful legal consideration.
Sole Proprietorship Business License

Sole Proprietorship Business License

Sole proprietorships offer simplicity and fewer formalities for new business owners, with benefits like no separate taxes. Remember, personal and business assets aren't distinct, impacting liabilities and the need for proper licensing.
What is the most important part of your business plan

What is the most important part of your business plan

The executive summary shines as the pivotal element of a business plan, serving as a decisive factor for readers to delve deeper. A comprehensive guide on crafting an impactful business plan, focusing on unique strategies and essential components.
Easy Businesses To Start

Easy Businesses To Start

Unleash your entrepreneurial spirit with these straightforward home-based business ideas, from e-commerce to creative pursuits. Embrace the flexibility and potential for financial independence with diverse options suited for various interests and investment levels.
What is the standard deduction

What is the standard deduction

Understand the IRS standard deduction, a straightforward option for reducing taxable income without needing detailed documentation. Delve into eligibility, amounts for 2023-2024, and considerations for itemizing versus standard deduction.
How to get a business license

How to get a business license

Grasp the essentials of obtaining a business license in California, focusing on local and state-level requirements. Uncover specifics on when and why different types of business licenses are needed.
Why Do Businesses Fail

Why Do Businesses Fail?

Uncover the key factors contributing to small business challenges, including financial obstacles, inadequate management, and flawed marketing strategies. Understand the role of a comprehensive business plan in ensuring long-term success.
What is a BOC 3

What is a BOC 3

Understand the essentials of a BOC-3 filing for transportation businesses in California, detailing the designation of process agents for FMCSA certification. Learn the requirements, costs, and benefits of choosing the right process agent for your business.
Standard deduction vs itemized deduction

Standard Deduction vs Itemized Deduction

Understand the key differences between standard and itemized deductions to effectively reduce your taxable income and potentially save on taxes. Choose wisely to maximize your tax benefits based on personal financial details.
How to calculate net income

How to calculate net income

Unveil the significance of calculating net income for business profitability, a key indicator for financial health and decision-making. Understand the formula and practical applications for determining net earnings.
Itemized deductions

Itemized Deductions: What they mean on a tax return

Optimize your tax return by understanding the differences between itemized and standard deductions, crucial for minimizing tax liability. Learn the benefits and challenges of itemizing to make informed financial decisions.
What are intangible assets

What Are Intangible Assets

Discover the value of intangible assets like patents and trademarks in your business, crucial for strategic and financial planning. Learn how to manage and amortize these non-physical yet essential resources.
What is accounting

What Is Accounting

Understand the importance of accounting in monitoring financial activities and making informed decisions for your business. Gain insight into accounting fundamentals and its role in legal and tax matters.
Dysfunctional family

Dysfunctional Family: Key traits and impacts

Explore the impact of growing up in a dysfunctional family, where constant conflict, neglect, and various addictions shape childhood experiences. Understand common traits, the consequences on children, and the cycle of unhealthy parenting behaviors.
When Was the Great Recession

When Was the Great Recession?

Delve into the Great Recession's timeline, an era of financial distress from December 2007 to June 2009. Understand the causes, including the 2007 housing bubble crash, and worldwide effects.
When Was the Last Recession in the US

When Was the Last Recession in the US?

Review discussions on America's most recent downturn, comparing the impacts and definitions of Covid-19 and the Great Recession. Analyze the significant effects of past economic crises on US policy and business approaches.
What to Invest in During a Recession- 4 Ideas

What to Invest in During a Recession: 4 Ideas

Uncover effective strategies for investing during a recession, assessing personal goals and current market situations. Examine four robust investment approaches to manage through economic declines effectively.
Will the US Get Hit with a Recession in 2024

Will the US Get Hit with a Recession in 2024?

Experts debate the likelihood of a 2024 US recession, analyzing factors like the yield curve and consumer confidence. Predictions vary, with a focus on interest rates and tech layoffs impacting the economy's future.
How Long Do Recessions Last

How Long Do Recessions Last?

Learn about typical US recession lengths and influencing factors, noting recent trends with shorter durations averaging 10 months. Investigate how external factors and government decisions affect recession timelines, comparing historical data.
When Will the Recession End

When Will the Recession End?

Economists predict a mild US recession with limited impact on employment and spending. The duration and impact of the recession depend on Federal Reserve policies and business cycle patterns.

© Copyright | Nakase Law Firm (2019)