Business Valuation: What is it & do I need it
Do you own a business or know someone who does? Chances are, nearly everyone will answer this question with a resounding, “Yes!” It’s a pretty simple question. However, there is another seemingly simple question that few business owners can answer: How much is my business worth?
Many owners say it doesn’t matter since they don’t plan to sell the business, their kids are going to take over someday, or an eventual sale is years away. This attitude is all too common among small and mid-size business owners. Unfortunately, waiting until you’re ready to retire to gauge the value of your business – or when you find out that your kids have no intention of taking over – could be a costly mistake.
A business valuation establishes a value for an entire or partial interest in a firm by taking into consideration the size of the business, its cash flow, industry and economic trends, and regulations impacting that specific business.
There are typically four situations to consider when deciding if you need a business valuation: transaction, taxation, regulation and litigation.
Transaction – This is when most owners look to a business valuation to establish a basis for themselves or their partners prior to a partial or outright sale of their business. In this situation, a valuation provides a conclusion of value that is expressed as a single value, or a range of values. This is useful for determining the fair market value of a business and aiding in the negotiation of deal terms and structure. That being said, waiting until the final hour to determine the value of your business is not recommended. Instead, annual valuations allow you to determine current value, and identify how far you have to go to reach your financial goals. The last thing you want is to be a few years away from retiring and excited to cash in on your hard work, only to learn that the business is worth a fraction of what you thought.
Taxation – In many cases, the value of a closely-held business becomes an individual’s primary asset, and should be protected from undue exposure to taxation. For example, you may plan on leaving your business or portion of the business to your spouse and other family members. Failing to properly set up your estate could lead to excessive taxation on inheritance or transfer of ownership rights. Historic and current tax court cases have shown that the Internal Revenue Service (IRS) allows for significant discounts in value – calculated by a certified valuation analyst (CVA) – to be taken when reporting assets on an individual’s estate or gift tax return. The potential tax savings from this process could be hundreds of thousands, or even millions, of dollars. However, to take advantage of these savings, a comprehensive estate or financial plan must be in place that accounts for the business value.
Regulation – In a buy-sell agreement, or buy-sell clause, an operating agreement exists in almost every business. This establishes the methodology used by the partners or shareholders for the disposition of a departing or deceased party. A formal business valuation would assist the partnership or corporation by addressing items like the events that trigger a buyout, the funding for a buyout, and the methodology for valuing the business interest. By preparing ahead of time, you can avoid disruptions to the business that impact revenue generating activities and protect all parties involved.
Litigation – Litigation may come in any number of forms, but the result is the same: lots of stress, business distractions and it may even cause more than a few grey hairs (or worse, hair loss). Fortunately, having a CVA perform periodic business valuations and assist in formal business planning can alieve some of this stress. In this situation, attorneys need CVAs to determine the value of a business or business interest before they can move forward with the litigation process. Some of these instances might include divorces, wrongful death and injury cases, partner disputes, and dissenting shareholder actions. Hiring a valuation expert with undisputed industry expertise may be the difference between being on the winning or losing end of a dispute.
If you find yourself in any of these situations, or would like to start planning for the future sale of your business now, a business valuation could be your next step. For a confidential discussion of your valuation needs, consult Topline Valuation Group, LLC.