Small business valuation – How to prepare for it

As a small business owner, by proactively preparing the business in advance of a valuation, you can ensure that you get the maximum value i.e. the full financial reward. As Alexander Graham Bell said, “Before anything else, preparation is the key to success”.

In our previous blogs, we discussed what is involved in valuation, why the traditional methods don’t apply to valuing a small business and the different factors that can influence the business valuation multipliers for your business. With that context, we will now guide you on how to prepare your SME/ small business for a valuation.

Firstly, you have to be clear about your purpose of why you (may) need a valuation and what has to be valued (e.g. a particular product, a part of the business or the whole business). This enables you to focus on and prioritise the key areas for preparation that will deliver a greater immediate impact.

It’s important to understand that a key objective of the business valuation is to evaluate the perceived risk associated with your business. So, your preparation should focus on de-risking your business in the eyes of the potential buyer. It is worth undertaking some initial research on your industry sector to understand the valuation methods commonly used in your industry, the market drivers and the analyst forecasts for your sector. This will help inform your preparation phase and potentially the timing of any sale or M&A.

Eight key focus areas while preparing for a small business valuation

There are eight key focus areas you need to consider from a ‘de-risking’ the business point of view while preparing for business valuation:small business valuation

  1. Getting your financial records in order

The starting point of a valuation is the analysis of your financial records. The most important ones being the 3-5 year record of your income statement, balance sheet and the cash flow statement. Make sure that your statements are aligned and structured to the requirements of the valuation/ appraiser; in that they cover all the key information which is easy to get to. An accountant or a financial adviser
can help you with that.

  1. Having key business documentation in place

As an SME you may have a relatively ad-hoc way of document management and filing. So, when the time comes, you’re struggling to find the necessary documents which might be misplaced or difficult to trace. Being well prepared involves having all key documentation in place, in the right order and easily accessible. These documents include, but are not limited to income statements, balance sheets, cash flow statements, P&L statements, tax records, IP documentation, legal documents (policies), HR/payroll data and so on.

  1. Focusing on sustainable revenue and sales pipeline

Many of the common valuation methods ‘factor in’ the future revenue growth potential of the business. If you can demonstrate sustainable revenue generation with a healthy sales pipeline and a credible business growth plan, it can have a significant impact on the valuation of your business. Our team can provide you with strategic growth advice, work with you to develop your growth plans and implement our predictable revenue model in your business to deliver a healthy and sustainable sales pipeline.

Together with the sales forecast and future growth plans, you’ll also need to have the historic sales reports in place for the last 3 to 5 years.

  1. Establishing a strong management team and developing succession plans

A strong management team with a well-established governance framework and defined management practices demonstrate stability, organisation and discipline within the business. This can positively influence the value of the business. Similarly, having defined succession plans for key roles manages the risk against any sudden changes that could impact the business.

As a business owner, it’s important that you put this in place within your business prior to any sale. You can talk to our business growth strategy advisors to help you in developing and implementing a governance framework and succession plans within your business.

  1. Defining systems and processes

Having defined systems and processes across all key areas of the business operations ensures consistency, efficiency and operational effectiveness. That is key for any potential buyer. It mitigates the risk that the business could lose its shape/quality under different leadership. It also makes the training of new workforce easier and ensures consistency in the quality of outputs produced by everyone in the business.

  1. Reducing owner dependence on business operations

If the key business operations depend on you, whether it’s service delivery, R&D or business development, any buyer will identify this as a key risk to the business. It does raise questions that whether everything is going to take a downturn after you leave? Will the business be able to sustain itself in the long-term without you?

Preparing for business valuation includes reducing the dependence of the business on you as the founder/owner of the business. By implementing points 4 & 5, you will have established a solid foundation to empower your team and establish a business operation that can become a self-sustaining entity.

  1. Transferring goodwill

Especially in the case of professional services firms, goodwill is associated with you, the founder/ owner rather than the business entity or the brand. This could mean that once you’re not around, the clients or the brand goes with you as well. Again, this makes the business unattractive for a potential buyer as there is no long-term gain from it.

As the owner, you need to transfer as much of that goodwill into the business and the key roles within it, whether it is your delivery team or the business development team. Help build and share the key relationships you have with clients/ suppliers with the relevant people in your business.

  1. Identifying potential intangible assets in the business

You will have a record of most of your tangible assets with value against them. However, the intangible assets that you may not have accounted for, could really increase the value of your business. You ought to consider all the knowledge capital you have developed in the business, potential IP and other intangible assets that are of great value. You should ensure that you have recorded all intangible assets and identified how you can improve them to further maximise their value for the business.

Conclusion

In preparing your business for a valuation, you need to identify and prioritise the areas where more work is required and where you will achieve the maximum impact on your business valuation. In our experience, a good starting point is to assess your business using a structured benchmark. This helps to identify key areas of improvement and enables you to put in place business improvement programmes so you can maximise the business valuation.

At Shaping Business, we use a structured framework to benchmark your business against the levers of business value creation. The output report can help you focus on the short, medium and long-term priorities to maximise the value of your business. Remember…

“Opportunity does not waste time with those who are unprepared”

– Idowu Koyenikan