You’re excited and eager to go—your small business has finally reached a point where you are ready to grow! The only problem is you need capital. You’ve seen the financial statements, you know your gross revenue, and you’ve seen just about every dollar symbol related to your business that you can. But how do you know what the shares in your business are really worth?
Here at Incorporation Attorney, we recently had a client right in that exact situation. They were looking to bring in additional capital but didn’t know how to calculate the fair market value per share for their small business. Keep reading as we take you through the steps to help them keep moving to grow their business.
Take Out the Guess Work When Your Small Business Needs to Raise Capital
There are a lot of reasons why you might need an injection of cash into your business. Is it time to upgrade equipment? Moving into a new building? Often, it’s an opportunity for growth that requires capital – a second (or third or fourth) location, a new revenue source, a need for more staff, etc.
Another motivator for bringing in the capital might be lagging profits and a need to cover operating costs until profitability improves. Perhaps you have a sub-optimal mix of debt and equity positions and you want to reshape your capital structure. Sometimes a company can suffer from too much debt and decide to relieve the pressure by increasing the equity held by an existing investor.
Whatever the reasoning, proper management of capital is something every successful business needs to master. And if you don’t know how to calculate your capital and fair market value per share for your small business, you could be leaving yourself guessing about your money.
Determining the Value of a Small Business
Recently, one of our clients found themselves needing additional capital to fund operations. Let’s look at an outline of the steps we used to determine the value of the business, and then how we structured the process of selling additional shares.
The decision was made that the influx of cash would come from an existing shareholder who wanted to increase their percentage of ownership in the corporation. From that point, we needed to find out several variables – the current value of the business, the current number of shares held, the value of each share, and the number of new shares that would be sold in exchange for the additional investment by the shareholder.
The first step was defining the current value of the business. There are several accepted means to evaluate the worth of a business, usually dependent on the situation and the purpose for which the valuation is needed. Understanding their goals, made it easy to see which approach was best for our client’s small business and then how to calculate their value per share.
Different Approaches to Calculate Business and Share Valuations
Business valuations generally fall into three categories:
Asset-Based Value Approach
An asset-based approach, where a business’s assets and liabilities are added together, with the result being the value of the company. This type of valuation is typically done when a complete business is being sold, so it wouldn’t be appropriate for what we’re doing today.
Earning Value Approach
An earning value approach, where a business is evaluated primarily for its potential for future earnings. The most common example of this methodology is Capitalizing Past Earning, where the company’s past earnings is examined as a means of projecting future potential. This approach might be used when a strategic investor is considering coming aboard (think of the Shark Tank investors). As such, it’s not appropriate to our goal.
Market Value Approach
A third approach is based on market value. This valuation represents what a buyer would be willing to pay for a business or a portion of a business when the buyer and seller both have a reasonable understanding of the business and are under no pressure to buy or sell. This method helps you determine a fair value within the market, which can then be divided among shares to determine their value. Since that most closely matched our client’s situation, this was the method we chose to use.
Step by Step: How to Calculate the Small Business’ Values Per Share Using the Fair Market Value Approach
In our client’s case, the seller of the shares was the corporation as a whole, and the buyer was the individual shareholder. Since both parties had intimate knowledge of the business and its operations, and there was no compulsion to buy or sell, they could mutually agree on the value of the company. All the shareholders agreed that the business was worth $430,000, so that was the starting figure for the process. It was also decided that the investor would be putting $70,000 into the business.
Once the value was determined, we still needed to know what each share was worth, so we would know how many to sell in this transaction. The formula to find that out is simple. We knew the total value of the business and we knew how many shares were currently owned by the existing shareholders. With those two pieces of information, we can divide the former by the latter, and that gave us a per-share price of $1.74.
Finally, we divide the amount of the new investment by the per-share price and find out that 44,230 is the number of shares that need to be sold. At that point, the value of the business becomes $500,000, and all of the shareholders own the number of shares that accurately reflect their equity position.
How to Calculate Share Prices Using Fair Market Value: Working with a Small Business Expert
Guessing how to calculate your small business’ fair market value and value per share is something no business owner should do. Working with an expert attorney on small business formation and maintenance not only ensures what you are doing is financially sound, but what your doing is legally sound.
Do you need help in calculating the fair market value of shares for your business? Ready to grow your business and make legal changes to your business structure? Give us a call today at 714-634-4838 to get help right away.
