How to Prepare for a Business Valuation: A Guide for Business Owners
How to Prepare for a Business Valuation: A Guide for Business Owners
If you're looking to sell your business or simply want to understand its real value, being well-prepared is key. From organizing financial documents to gathering key performance indicators (KPIs), there are several steps to make your business valuation process go as smoothly as possible.
As BizBuySell explains, "Business owners and buyers have many tools at their disposal to gauge the market and determine a fair value for a business, but it's important to consider enlisting professional help, especially as values increase. Self-valuation may be appropriate when buying or selling businesses under a couple hundred thousand dollars, but as values increase, so do the risks of over/undervaluing. Hiring a professional business appraiser or business broker not only allows you to benefit from their expertise, but it also provides the objectivity that you may lack when it comes to making a fair assessment of the business. Many brokers are experienced at conducting a formal valuation or have connections with qualified appraisers." Professional guidance ensures that your valuation reflects the true market worth of your business and instills confidence in potential buyers. Read more at BizBuySell.
Here's what you'll need to ensure an accurate and impressive Market Price Valuation.
Essential Financial Documents for Your Valuation
Understanding the true value of your business goes beyond just the numbers; it requires an analysis of multiple dimensions. As the U.S. Chamber of Commerce explains, "The valuation process tells the owner what the current worth of their business is by analyzing all aspects of the business, including the company’s management, capital structure, future earnings, and the market value of its assets." This holistic approach ensures a comprehensive understanding of your business's worth and highlights areas that can impact its market value. Read more at the U.S. Chamber of Commerce.
To get started, you'll need to gather the financial documents that provide a complete picture of your business's financial health. These documents will allow a valuation expert to assess profitability, growth potential, and operational efficiency.
Key Documents to Gather:
Tax Returns (Last 3 Years)
Updated tax filings give a baseline for revenue and expenses, showing how the business has performed over time. Potential buyers will review these documents to confirm the business is profitable, looking for consistency and trends.
Profit and Loss Statements (P&L)
The P&L statements shows a potential buyer how much revenue and profit your business generates on a regular basis. This is a core document to demonstrate financial performance and profitability, and gives insight into the numbers found on the business's tax returns.
Balance Sheets
Balance sheets provide a great snapshot of assets, liabilities, and the owner's equity. This document helps establish a clear understanding of the business’s financial position. These documents also add clarity to the tax returns and P&L, and very helpful for potential buyers.
Asset Lists
Any valuable assets for the business, such as real estate, vehicles, machinery, or any large equipment that will be part of the sale should be gathered in one place, and should be documented with an approximate value for each item/category.
Inventory Details
Having an up-to-date count and approximate value of inventory can significantly impact the valuation, especially for product-focused businesses. Most POS or inventory management softwares will have this available, and so should be easily available.
Accounts Payable & Receivable
These documents show outstanding obligations and payments owed to the company, reflecting cash flow and financial health. If your business doesn't settle payments immediately, for both sales made and company purchases, then the accounts payable and receivable could significantly alter the true financial picture of the business.
Franchise or Licensing Agreements (if applicable)
For franchisees or businesses operating with specific licenses/provisions, these agreements provide essential context on rights, fees, and operating limitations, and so are imperative when showcasing the business listing.
"The more organized you are with these documents, the smoother the valuation process will be. Ensure everything is up-to-date and accurate to avoid delays and discrepancies. If needed, you work with your tax/financial advisor to secure these documents."
Key Performance Indicators (KPIs) for Marketing-Driven Businesses
If your business relies heavily on advertising or marketing to drive sales, it’s essential to have detailed marketing KPIs available. This data not only showcases the effectiveness of your advertising strategies but also builds confidence among potential buyers in the business’s scalability and ROI.
As CFO Bridge explains, "Ensuring accuracy and transparency in financial reporting is critical for any business looking to maintain stakeholder trust, comply with regulations, and make informed decisions." This principle applies to marketing metrics as well—clear and accurate KPIs not only reflect the current state of your business but also help buyers envision its growth potential. Read more at CFO Bridge.
Important Marketing KPIs to Include:
Return on Investment (ROI) for each major advertising channel.
Customer Acquisition Cost (CAC): The cost of acquiring a new customer.
Customer Lifetime Value (CLV): The average value each customer brings over their relationship with your business.
Conversion Rates: The percentage of leads or website visitors that become paying customers.
"Having these metrics available provides a clear view of the marketing efficiency and customer behavior, adding to the business’s perceived value and showcasing growth potential."
Financial Transparency and the Importance of Accurate Records
Many business owners, especially in the early years of operation, may be tempted to use “creative” accounting practices to shield profits or reduce taxable income. However, while this may offer short-term benefits, it can distort the true picture of the business's financial health. As Harvard Business School explains, "When examining earnings, financial analysts don't like to look at a company's raw net income profitability. It’s often manipulated in a lot of ways by the conventions of accounting, and some can even distort the true picture." These distortions can create challenges during the valuation process and lead to a lack of confidence among potential buyers. Read more at Harvard Business School Online.
In preparation for a business valuation, it’s essential to have legitimate and transparent financial records. Any ‘creative accounting’ practices that obscure profits or inflate expenses can lead to challenges in showing the business’s true value to a prospective buyer. When we review a company’s financials, we look for an accurate representation of its earnings, and so does any buyer. If adjustments or amendments are needed, we may have to ‘normalize’ the financials to present a clearer picture before listing your business on the market.
When preparing for a business valuation, financial transparency is critical. Potential buyers value clarity in financial records, as it builds trust and confidence in the business's fundamentals. As Investopedia emphasizes, "Investors should seek disclosure and simplicity. The more companies say about where they are making money and how they are spending their resources, the more confident investors can be about their fundamentals." This principle applies directly to business owners—transparent and straightforward records not only make the valuation process smoother but also increase the perceived value of your business. Read more at Investopedia.
Potential buyers value honesty and clarity in financial records. If your financials are not straightforward, thorough, or contain too many “creative” elements, it can create doubts and diminish the perceived value of your business. Aim to provide clean records that represent the business’s real performance accurately, or work with your financial advisor on how you can clean that up.
Tip for Business Owners thinking of Selling:
"While it may be tempting to minimize profits on your taxes, keep in mind that a higher reported profit typically translates to a higher valuation when listing your business. The ‘hidden’ earnings you save on taxes may ultimately reduce the value potential buyers see, and the final price you may get when selling."
Preparing Your Operational and Additional Documentation
Preparation is a cornerstone of a successful business valuation and eventual sale. Ideally, this process should begin well before you start engaging potential buyers. As Plante Moran advises, "Ideally, business readiness planning should start before you start looking for a buyer or even mention the possibility of a sale to your staff. We recommend meeting with your advisors to review the business, how it’s positioned in the current market, and what’s needed to prepare it for sale." Taking the time to plan ensures that your business is not only appealing to buyers but also well-prepared for a smooth transition. Read more at Plante Moran.
Beyond financials, other documents that showcase the structure, efficiency, and worth of your business can enhance the valuation process. These documents include:
Employee Contracts and Key Roles
Demonstrating the stability and talent within your team is valuable to potential buyers. If you have large teams running things, your buyer will likely need that same support.
Customer & Client Lists
Detailing recurring clients or large contracts can showcase stable revenue streams and business relationships. Also showing prominent names in your Company Rolodex can help strengthen your positioning with a potential buyer.
Supplier Agreements
Show the reliability of your supply chain, especially if your business relies heavily on specific suppliers. Also showing your history with suppliers in which you've had a long relationship, or where they have gone out of their way to facilitate your company is always a plus.
Operational Processes and Standard Operating Procedures (SOPs)
Detailed SOPs show that your business is structured, organized, and ready for a seamless transition can be instrumental in a buyer's decision to move forward, especially in cases where it is not clear if the current staff will stay on with the new ownership.
"When preparing for a valuation, consider what a potential buyer would want to know beyond the numbers, and what they would be worried about if they did purchase your business. Documents that showcase your business’s operational strength, client base, and supply chain stability add value and credibility to your valuation."
Receiving a Market Price Analysis
Thinking about selling your business? Reach out to us today to discuss how we can guide you through the valuation process and help maximize your company’s worth. We've been doing this for over 30 years, and would love to help you understand your business's true worth.
If you'd rather see some preliminary figures before speaking, please try our new Market Price Analysis (MPA) Calculator. This will give you a general price you could expect should you decide to sell. Please be aware that there are many factors that go into the valuation, as discussed in this article, and so we will need to gather all of the necessary documents before providing a documented valuation that could be showcased to potential buyers.
Try the MPA Calculator for Yourself
Conclusion
Preparing for a business valuation involves more than just numbers; it’s about presenting a well-rounded picture of your business’s worth and health. By gathering essential financials, demonstrating transparency, and showcasing key metrics, you ensure that potential buyers see the full value your business offers. Remember, accurate, well-organized documents not only make the valuation process smoother but also help build trust and confidence with prospective buyers.
As U.S. Bank notes, "Selling a business requires in-depth knowledge of your financial priorities, along with expertise related to this type of transaction. It may require the support of advisors or specialists who can contribute additional insights to the process." Enlisting the right professionals not only enhances your preparation but also helps you navigate complex aspects of the valuation and sale, ensuring a successful outcome. Read more at U.S. Bank.
