Business Valuation: Knowing Your SMB’s Worth

Although it’s a relatively new federal holiday, Juneteenth carries with it a weighty significance.

In the official declaration via the Emancipation Proclamation, Abraham Lincoln wrote:

“I do order and declare that all persons held as slaves within said designated States, and parts of States, are, and henceforward shall be free…”

This holiday which we celebrated nationwide this week marks the crucial moment when our nation took a big step toward valuing ALL people as equal and free.

Imbuing value where value hasn’t previously been given is something that often means making a stand and fighting until it’s recognized. It’s why 340,000 UPS workers are threatening a strike. They feel undervalued, so they’re fighting for their company to officially rethink their value.

It’s not enough to simply know your own value. Others need to see it too.

And that’s why I want to talk about the value of your Wilmington business. Knowing what your business is worth — while not about intrinsic human worth or worker’s rights — is essential to how you will operate and how others will see you as well.

Because there are moments in your business’s lifespan that will require you to stand on that valuation including the day that you think of selling it or passing it on.

Let’s start here…

Business Valuation: Knowing Your Wilmington SMB’s Worth
“Try not to become a man of success, but rather try to become a man of value.” – Einstein

Determining the economic value of your small business is a key part not only of your ongoing operations but also of many milestones in the company’s life, including its eventual sale. What is a “business valuation”?

There are two general kinds with different purposes:

A fair market valuation uses qualitative methods, looking at a few years of your operations to determine what your company’s worth in the market and its potential earnings for a prospective buyer. For this, you’d need a broker or an M&A advisor, and would cost in the low five figures.
Legal valuations use quantitative measures of around a half-dozen years of your company. These are specific – to the point of being able to hold up in court, as you can guess from the name – and have to be done by a certified appraiser or professional. These are pricier and don’t necessarily reflect how a prospective buyer or investor would look at your business.

Let’s look at what details of your business you should be prepared to show for a valuation.

What’s looked at

Basically, a business valuation stacks up your company’s assets versus its liabilities, the value of everything your business owns minus its debts or liabilities. Areas to be examined include:

Capital structure: Your company’s balance of owner/staff equity, debt, and reserves. (A company with a higher debt-equity ratio is highly leveraged.)

Earnings current and potential: What are your levels of sales, especially compared with other similarly sized companies in your industry? Two common methods of calculating earnings are EBIT (earnings before interest and taxes) and EBITDA (Earnings before interest, taxes, depreciation, and amortization). Another method is discounted cash-flow analysis, which looks at the business’s projected annual cash flow discounted to today’s value. (We’ll talk more about this in the next article.)

Management: Their length of tenure, work ethic, and time spent on business operations day to day, as well as their investment such as stock options and your managers’ goals as spelled out by the mission statement. Another key factor: compensation by industry benchmark.

Market value of assets: This could include equipment/furniture, property, intellectual capital (the biggest problem here can be outdated equipment). Non-operating assets can include commercial real estate, stocks and bonds, related entities, and surplus cash, so be prepared with documentation on these as well.

You should also be prepared to discuss less-tangible aspects of your company’s worth, such as location, community presence, marketplace reputation, and so on.

Documents you’ll need

The more paperwork you can provide for your business the better, but the basics include three years’ income tax returns; a current P&L statement and balance sheet; three years’ P&Ls and/or balance sheets; a YTD income statement with a comparison to last year; an estimate of your company’s current inventory at cost; a list of intellectual capital; and an asset listing of furniture, fixtures, equipment and sellable inventory at approximate current market value.

A new notes:

Be prepared to present your complete tax returns; a few pages won’t give an adequate picture. Include such as depreciation schedules, K-1s, and shareholder info.
Your P&Ls can reveal insights into your business performance, including your strengths and weaknesses. These documents don’t need to match your tax returns precisely but they should be very close unless you have a compelling (and well-explained) accounting reason they don’t.
The YTD statement may not be needed early in a calendar year, but you should still have ready the most current income statement possible. Your current balance sheet will also show your A/R and inventory to the moment – and may be much more accurate than year-end figures.

Your advisor may also need details of major contracts; equipment leases and depreciation schedules; business plans and forecasts; property deeds and leases; property appraisals; loan agreements; and details of pending litigation.

Who and when

Your company’s valuation is critical and unless you really know what you’re doing, a DIY approach is not best. You’ll need a professional. More than one, usually. Getting input from multiple professionals will ensure you get an accurate valuation, better negotiating power for the valuation, and all the information you need to make the right business decisions (like selling your business, raising capital, expansion, etc).

Next time, we’ll get more into what to ask when finding the right people for you, but generally, you’ll be looking among attorneys, CPAs (we’re happy to help), business brokers, M&A advisors, even appraisers. Keep in mind: Your valuation might take up to six weeks.

We’ll also look at when and under what circumstances you might need a business valuation in the next article. Be on the lookout for that.

And, as always, my team and I here at Century Accounting and Tax Services, Inc. are here to help provide whatever you need to run your Wilmington business.

Looking out for you,

Karen S. Durda, EA