How to avoid screwing up your valuation

Too many businesses make mistakes early on that screw up their valuation later. We talked to a chartered business valuator about what to avoid.

This is the first in a two-part article about strategies for a successful valuation. Next week, we’ll talk about the differences between valuating public and private businesses. Subscribe here to be notified when it comes out.

The sale of a business starts from day one. Each new client brought in and each expertly executed strategic pivot is a testament to the health of a business, a marker in the company’s DNA that ultimately brings value to the stakeholder(s), be it family-run or a multinational. By the same logic, shoddy decision making and disenfranchised customers will do the opposite.

Which is why it’s important to recognize that the choices you make – the blood and sweat you put into your business – will impact how much your business is worth down the road when it comes time to have it put under the microscope by a chartered business valuator.

We’ve already looked at how to know when to sell your business, but this time around, we’re taking a look at the business valuation process and how take steps now to avoid shooting yourself in the foot later.

The Dealroom chatted with Craig Maloney, a chartered accountant, chartered business valuator and partner at WBLI LLP to get the low down on avoiding completely screwing up your business valuation.

In the beginning…

First thing’s first: Business owners should be keeping diligent financial records and ensure all assets and expenditures are related to the operations of the business as opposed to personal in nature.

“Some business owners choose to expense certain items in a liberal manner that do not have a real business benefit,” says Maloney.

During the valuation or transaction scenario, these liberal expenses may come back to haunt the owner.

“The CRA may challenge some of the expenses that have flowed through the business as being a personal benefit to the shareholders and a CBV must normalize or adjust the non-business expense items,” says Maloney. “Fewer normalizations and adjustments will reduce the risk of the business, and increase the value of the business, other things being equal.”

What to keep

Along with documenting financial dealings – including detailed records of fixed assets, aged accounts receivable, and inventory listings and any appraisals or professional reports prepared for the company – business owners should also take steps to implement and record the nuances, procedures and controls of running the business.

Maloney recommends business owners formalize the organizational structure and write out detailed job descriptions for all key roles.

“A valuator will want to get an understanding of the company and its industry through discussions with management and review of things like a business plan, the company’s website and other similar documents,” says Maloney. “A management discussion of annual budget to actual figures can be helpful in understanding the year over year trends of the business (and) can also be a good practice for management to utilize as part of its annual budget process.”

The Process

Typically, a CBV will look over the past five years worth of financial statements and tax returns for the business as well as examine the company’s forecast for the next two years.

“A valuator will review the historical trends of the company’s income statement to determine the annual cash flow generated after adjusting for any one-time or unusual items,” says Maloney adding that after looking at forecasts, budgets and breakdown of revenues, the valuator will seek to understand and estimate the future cash flow. “History is usually a good predictor of the future, but not always.”

They will also appraise any real property or any other assets that are worth more than their accounting book values.

The handoff

One of the biggest challenges owner-managers face in the hand off is converting the personal goodwill in the business to commercial goodwill.

“Personal goodwill is when the owner-manager is the business – he or she has the relationships with the customers and suppliers,” says Maloney adding that a key indicator is when the owner can’t take a holiday without interrupting the flow of the business. “Owner-managers should look to transition their roles and duties early on in the business cycle, and seek to train a capable management team whenever possible.”

Not only will a knowledgeable and experienced management team assist the owner with their transition goals, it will increase the value of the business by offering a turn-key scenario for a prospective purchaser

“Purchasers generally place a lot of value in a competent management team that is willing to stay on with the business post transition,” he says.

Transferring personal goodwill to commercial goodwill also means the business should have multiple contacts for key customers and suppliers, such that the key customers/suppliers are dealing with the business as opposed to a single individual.

“In other words, ensure that the customer relationship is with the business vs. the individual,” adds Maloney.

And if you get hung up, seek counsel from a CBV.

“Whether it is in the context of mergers and acquisitions, succession planning, strategic planning, or reorganizations, CBVs are recognized as experts when it comes to business valuation,” he says.

Andrew Seale

Andrew Seale is a Toronto-based business writer who contributes frequently to Yahoo Canada Finance, The Globe and Mail's Report on Business and The Toronto Star.