Small-Business Services: Understanding Business Valuations

By Joseph Hill, Jr. | MBA | MSF

Recognizing that many of our clients are entrepreneurs, BWFA last year added a division to support small businesses. Business valuations are one of the most important services that this division provides.

A business valuation is just what the term implies: an evaluation of the worth of the business, made by an independent third party. A professionally prepared business valuation is a formidable resource for any business. For a business is seeking capital to grow, the evaluation is crucial to obtaining investments or bank loans. For potential buyers and sellers of a business, the valuation sets a fair price for a business, from which a deal can be struck.

Valuation Approaches

A BWFA valuation analyst estimates the value of a business by utilizing professional judgment and applying standardized analytics and methods. The three most common valuation approaches are the income-based approach, asset-based approach, and the market-based approach, each of which provides a different perspective.

Any single business valuation approach or a combination of two or all three approaches might be appropriate for valuing a particular business. How the analyst uses these approaches will depend on the facts and circumstances.

  • Income-based approach. The valuation analyst determines the expected level of cash flow for the business, basing the estimate on the business’s historic earnings and expected changes (growth or decline) in future earnings.
  • Asset-based approach. The analyst determines the net cash that would be received if all assets were sold and liabilities paid.
  • Market-based approach. The analyst estimates the value by comparing the business with similar businesses that have already been sold.

Valuation Process

For our clients, BWFA’s business valuation process consists of six steps. These steps ensure that everyone is informed about the objectives of the evaluation and that all of the relevant information is obtained and analyzed:

  • Phase 1: Goals. An initial conversation that enables our valuation analyst to learn about the goals of the client and the purpose of the business valuation.
  • Phase 2: Letter of engagement. The letter clearly states the scope of the valuation, basis of valuation, fees and terms. The letter is signed by the instructing parties and the valuation analyst.
  • Phase 3: Discovery.  The analyst requests and gathers documents, interviews owners/management, and (possibly) inspects the business.
  • Phase 4: Research and analysis. After receiving the information, analyst conducts research and performs analysis of the business.
  • Phase 5: Valuation. The analyst selects the appropriate valuation approach(es).
  • Phase 6: Report. The analyst provides a readable, understandable and defendable report to the intended users.

 If you are seeking access to capital, considering the acquisition of a business, or contemplating the sale of a business, talk to us about our small-business valuation services.