17 Apr Key Documents for Business Valuation

Written by: Philip Acinapuro

(5-7 minute read)

An accurate business valuation report starts with proper documentation requests. Providing more information up front could help expedite the valuation process. Each of the following documents plays a key role within the business valuation and will impact the analysis, structure, accuracy, and/ or narrative included within the report.

Required Documents

Historical Financials
The Appraiser utilizes three years of historical income statements to analyze trends across revenue, expenses, and profitability. If the business has been operating for less than three years, then all available years are requested. This level of historical operations provides the Appraiser with enough information to properly analyze the operations of the business and consider any growth, declines, or outliers when considering weighting of the financials. If available, the Appraiser will also review historical balance sheets to identify any trends in assets or liabilities that may need to be questioned. Financial records are generally viewed in the following order of reliability:

• Audited: subject to the highest level of independent verification
• Accountant-Reviewed: provides limited independent verification
• Federal Tax Returns: offers consistency and credibility as they are submitted to the IRS but provides no verification
• Accountant-Compiled: created based on client-provided data with no verification by the preparer
• Internally-Prepared: created in-house by the Company with no outside verification

Typically, it is important to match the financials in the business valuation to the financials used for underwriting purposes. However, as you can read here: https://reliantvalue.com/cash-vs-accrual-accounting/, the accounting basis of the financials can sometimes matter more than the type of financials, if they are deemed reliable. Depending on the industry, the Appraiser may request accrual financials instead of cash financials to complete the business valuation.

Most Recent Year-to-Date Income Statement
This document provides insight into the Company’s current year profitability, allowing for comparison to the historical years. For mid-year effective dates, this income statement will show operations for a partial year, creating the basis for the Appraiser’s full-year projections. An interim period income statement with the same accounting basis as the historical years is generally preferred or may be required, depending on the industry.

Most Recent Year-to-Date Balance Sheet
The balance sheet offers a recent snapshot of the company’s assets, liabilities, and equity. The Appraiser will adjust for any non-operating assets and liabilities and ensure that only the specified operating assets and liabilities are included in the Final Value. The balance sheet also allows the Appraiser to compare the Company’s working capital items to industry averages. Lastly, the balance sheet allows the Appraiser to assess the Company’s level of fixed capital, which may impact its collateral risk when calculating the company-specific risk premium. An interim period balance sheet with the same accounting basis as the historical years is generally preferred or may be required, depending on the industry.

Transaction/Bank Documents

Purchase Agreement or Letter of Intent (LOI) to Purchase
The Purchase Agreement or LOI to Purchase outlines key terms of a proposed transaction and often includes the structure (asset vs. stock sale), purchase price, and transferring assets and liabilities. Contingencies, such as consulting agreements or non-compete clauses, are also often outlined in these documents. Per SOP 50 10 8, “In order for the individual performing the business valuation to identify the scope of work appropriately, the business valuation must be requested by and prepared for the Lender. The scope of work should identify whether the transaction is an asset purchase or stock purchase and be specific enough for the individual performing the business valuation to know what is included in the sale (including any assumed debt)…” [1] This document usually allows the Appraiser to understand the structure of the deal with limited questions for the seller/ borrower.

Lender’s Credit Write-Up
Although our valuation conclusions are ultimately independent of our clients’ analysis, reviewing the lender’s Credit Write-Up can provide useful qualitative information about the subject company. This document is not necessary for the valuation, but having access to all available information will make for a more thorough and complete valuation. The Credit Write-Up may also answer some of the Appraiser’s preliminary questions upfront, which can reduce the questions asked to the contact.

Lender’s Commitment Letter or Letter of Intent to Finance
The lender’s Commitment Letter or Letter of Intent to Finance will often feature an in-depth breakdown of the loan structure. This may include information on inventory or working capital not specified in the LOI to Purchase or Purchase Agreement.

Other Documents Helpful to Analysis

Accounts Receivable and Accounts Payable Aging Reports (if applicable)
These reports are utilized to assist the Appraiser in adjusting for collectability of the balances on the interim balance sheet. They are particularly important if accounts receivable and accounts payable will transfer in the subject transaction, but the Company has provided cash basis financials for the valuation. In these instances, the Appraiser will use the reports to add accounts receivable and accounts payable to the balance sheet.

Copy of Real Estate Appraisal (if applicable)
The fair market value standard requires that a fair market rent is reflected within the valuation of a company, which may require a rent adjustment. If the real estate is being sold (either in the subject transaction or a related transaction) the Appraiser will be required to utilize a fair market rent estimate. There are methods that the Appraiser can utilize to estimate rent; however, a real estate appraisal prepared for the lender by a certified real estate appraiser will offer the most accurate estimate, which will, in turn, lead to a more accurate valuation result.

Company’s Pro-Forma Projections (2 Years)
Generally, the Appraiser will utilize a mix of historical data, industry data, and projections (when available) in creating projections for the subject company. While projections are not strictly necessary for a valuation, reviewing the seller’s expectations for the Company makes for a more thorough and complete valuation. When reviewing projections, the Appraiser will look for sales and expense discrepancies compared to the current performance of the Company, which may warrant further due diligence.

Reviewing multiple years of projections allows the Appraiser to assess the future expected operations. Two year forecasts are typically easier to create than longer time horizons and are more readily available.

Conclusion

Each of the documents outlined above plays a critical role in creating a thorough business valuation. While not all documents are required in every engagement, having access to all available information strengthens the overall credibility of the valuation and helps expedite the process. If you are considering an engagement with us and have any questions about required documents, please feel free to reach out to our team, who will be more than happy to assist.

[1] U.S. Small Business Administration, Standard Operating Procedure (SOP) 50 10 8 p. 142