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Business Valuation in Financial Planning for Business Owners | RISR Encyclopedia for Financial Advisors working with Business Owners Business Valuation in Financial Planning for Business Owners
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Current business valuation

✨ In summary

Estimating current business value is a pillar for financial advisors serving business owner clients.

 

Understanding the value of the owner’s most important asset unlocks key services across financial planning, wealth management, succession and exit planning, tax planning, estate planning, and risk management.

Business Valuation: Equity Value v. Enterprise Value

When working with business owners as a financial advisor, it’s important to focus on the Equity Value within the business. This is a nuanced difference from Enterprise Value and is intentional.

 

Enterprise Value reflects the value of the business or firm itself.

  • Businesses use a combination of equity and debt to finance their value-driving assets
  • Enterprise Value includes the value of this equity and debt, making it easier for potential buyers to compare businesses with different mixes of equity and debt (referred to as capital structure).
  • For this reason, Enterprise Value is most relevant to hypothetical buyers of the business.

Equity Value reflects the value of the equity in the business.

  • In the event of a sale, debt liabilities would first need to be satisfied with excesses in liquid assets
  • The remaining value represents Equity Value, the value the shareholders are owed
  • This reflects the value that owners of the business could expect to receive in the event of a sale
  • For this reason, Equity Value is most relevant when developing comprehensive financial plans with business owners

To help financial advisors working with business owners, RISR automatically estimates the value of all the equity in the business (Equity Value) as well as the value of the equity owned by the client (in cases where the client does not own 100% of equity).

How RISR estimates business valuation for financial planning

RISR follows these steps to estimate the Equity Value of client's business:

  1. Apply three best practice methods to estimate Enterprise Valuation (detailed below)
  2. Add net working capital to and subtract interest-bearing debt from each Enterprise Value output to estimate Equity Value
  3. Aggregate estimates of Equity Value to identify and remove any outliers across methods
Equity Value = Enterprise Value + Net Working Capital - Interest-bearing Debt

 

The three methods RISR uses to estimate Enterprise Value are:

For a detailed look into each of these methods and how they are applied in RISR, download our Valuation Explainer Guide.

Frequently asked questions

How can financial advisors use business valuations to engage clients?

 

Prospecting with Business Owners:

  • Use valuation as a leading value-add when prospecting with business owners.
  • Most owners don’t have a reasonable estimate of their business’s value and are open to sharing key data to gain that insight.
  • This type of discovery is perfect for finding where owners may need deeper financial guidance.

Wealth Diversification:

  • Use valuation to help clients see how much of their wealth is tied up in their business, guiding decisions around diversification into other assets.

Retirement Planning:

  • Compare what the business is worth today to what it needs to be worth to fund the owner’s life goals after exit
  • Understanding the relationship between current and goal valuation is a core component of cash flow planning and retirement strategy creation with business owners.

Succession & Exit Planning:

Risk Management:

  • Identify risks to the business’s value that may be impacting the client’s equity value and advise on ways to mitigate these risks for long-term stability.

Insurance:

Tax Planning:

  • Provide insight into the tax implications of selling or transferring the business by understanding its future liquidity potential.

What data is needed to estimate business valuation for clients?

 

Profit & Loss and Balance Sheet statements

  • The most recent 1 to 3 years of Profit & Loss and Balance Sheet statements are required to estimate business valuation
  • Most owners are curious enough about their business value to share this data
  • Ask clients for their recent business tax returns during onboarding or discovery (IRS Forms 1120, 1120-S, 1040, or 1065 depending on the tax structure of the business)
  • If tax returns are unavailable, accounting software like QuickBooks is also a good source for this data. Be sure to confirm with the client or their accountant that their bookkeeping is up to date within the software before relying on this data to estimate valuation.

💡 Advisors can use RISR’s business tax return reader to upload and extract data from client business tax returns in minutes. RISR also has a QuickBooks integration that makes it easy to aggregate business financials directly from a client's bookkeeping. 

 

An estimate of business risk

  • To get a sense of the potential risks to future business performance, ask about the businesses characteristics and operating practices:
    • How many customers does the business have?
    • How much revenue is generated by the top 5 customers?
    • What percent of revenue is recurring, renewing, or one-time?
    • What percent of revenue relies on any one vendor?
    • How are financial records maintained for the business?
    • If the owner departed from the business today, how likely is it that revenue and/or profitability declines?
    • If key employees departed from the business today, how likely is it that revenue and/or profitability declines?

💡 RISR's digital fact finder makes it easy for advisors to assess business risks and show clients how it impacts their valuation. 

 

Industry NAICS code and comparable benchmarks

  • Identifying the right industry code is a key step in the business valuation process
  • Work with the business owner and use search and answer engine tools to identify an appropriate NAICS code based on what the business does
  • Once selected, find comparable businesses within the industry that have sold to understand the ratio between their valuation and key metrics like earnings and revenue

💡 RISR references a database of over 800 industry NAICS codes and automatically pulls and applies comparable industry benchmarks to estimate valuation for advisors and their clients.

Why is it so important to normalize earnings when estimating business valuation?

 

Most businesses have unusual, non-recurring, or discretionary expenses that do not directly impact business operations.

Adjusting for these expenses normalizes EBITDA to better reflect the business's true ability to generate earnings

  • Normalized EBITDA is a foundational component to estimating business value as it represents a business’s ability to generate earnings in the future
  • It is typically based on an average of recent historic EBITDA plus any adjustments to remove unusual, non-recurring, or discretionary expenses to better reflect true earnings
  • Earnings need to be normalized because most businesses have unusual, non-recurring, or discretionary expenses on their books
  • This typically includes expenses like annual profit sharing, excess owner compensation, charitable contributions, and other discretionary expenses
  • To properly reflect the company’s ability to generate earnings, these expenses are added back to the estimate of future earnings
  • Work with the client and their accountant to properly estimate adjustments to normalize EBITDA

💡 RISR allows advisors and their clients to input adjustments or "add-backs" to normalize EBITDA and more accurately estimate business value.

How often should I update a business’s valuation and why is it important for financial planning?
 
Business valuations should be updated at least annually
  • It's best practice to use audited financial data for estimating business valuations, which is most easily accessible in a client's business tax returns
  • Add a valuation update touch point to your client engagement calendar in the late spring and work closely with client accountants to know when updated tax returns become available
What is the biggest mistake to avoid when estimating valuation on behalf of clients?

 

Biggest mistake: Treating the client's most important asset as a plug-in number

  • Business valuation is a pillar to deeper financial planning with business owners
  • In the past, financial planning with business owners has consisted of simply plugging in a rough placeholder value into the owner's financial plans 
  • With the development of better business valuation software in recent years, more accurate estimates of this value have evolved, but business are still being treated as plug-in values into financial plans
  • Business owners want to know their advisors understand their most important asset and have a comprehensive approach to integrating it into their life goals
  • Build deeper trust with clients by using business valuation as a starting point to deeper conversations like:

💡 RISR is made for financial advisors that want to build comprehensive trust with business owners without having to become specialists or reinvent their practice. Show your clients how their business fits into their life plans with branded deliverables across business valuation, wealth planning, succession & exit planning, and risk management. 

Additional Resources

RISR Valuation Model Explainer

 

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