Small Business Valuation Primer

For simplicity’s sake, this article will assume that the buyer will be acquiring a single business with possibly more than one location (for example a small Laundromat business with two locations). In addition, we will not be covering valuation techniques for businesses where more than one product line or service will be acquired. For the purpose of this discussion, we willto assume the simplest of all cases. For example if a buyer is acquiring a retail business, that business will be assumed to sell one type of product (for example, children’s clothing). This book is also assuming that its reader will be buying, or intends to buy, a small business that is privately held and valued at $1MM or less.
Finally, we will be focusing on valuing a business that is not going to be turned around, but will continue to operate (or grow) as purchased, under the new owner. A business that is failing and in need of an experienced buyer to re-structure and turn it around, or fix it, has to be valued using a different set of valuation metrics. Note that even though there are many ways to value a business, to keep things simple, and in light of its audience, this book will be using a straight forward multiple of earnings (net income) method to help a buyer arrive at a value that is as close as possible to the intrinsic value of the business. But keep in mind that in the end a business’ value is equal to what a buyer is willing to pay and a seller willing to accept.
To analyze a business, we begin by collecting and reorganizing its accounting and financial statements. Below is a list of essential documents that need to be gathered and analyzed. To make this analysis worthwhile, financials statements for at least the past three years must be available, preferably on a monthly basis. We recommend buying a business that has been operating (and has been profitable) for at least three full years:
Valuation Document Collection
Item No.Document DescriptionDate Collected
Income statement (Profit and Loss)
Balance sheet (Assets and Liabilities)
Cash flow statement
Monthly bank statements
Equipment list with replacement value
List of customers and contracts (with length of time left on contracts)
Employee roster with description of responsibility and salary information
Owners’ percentage interest along with salary and benefits information (health, insurance, company car, etc)
Copy of lease agreement
Lines of credit, if applicable
Note that most brokers and owners will require that you sign a confidentiality agreement and put down a “good-faith” (different from a down payment) deposit before you are given access to such confidential information. That is normal procedure and you should be ready to remit at least 0.50% of your offer price (not the owner’s asking price) to the broker to be put in escrow. Some brokers use a fixed amount (e.g. $1,000). That amount is used as proof that you are serious about buying