Valuing a Closely-Held Business

There are many reasons why a business owner might need or want to value a closely-held business. These include:

(1) Planning for estate liquidity

(2) Making a gift to a family member, a friend or to charity

(3) Properly recognizing the business worth in a pre or post nuptial agreement or a marital dissolution

(4) Ascertaining worth for loan collateral purposes

(5) Performing a “fiscal checkup” to test the financial health of, or trends in, the business, or

(6) A buy-out necessitated by death or disability, at retirement, or the sale of an interest in the business to a third party.

Here are some of the key factors (assigning more weight as appropriate to the factors that most influence the future financial success of the business being valued) that must be considered:

Nature and history of the business: How risky or stable is it? How strong is its management? How diverse is its operations? Is it growing or shrinking? What significant events have shaped its past or could shape its future?

Economic outlook in general and for specific industry: What’s happening in the general economy? What’s happening in the specific industry?

Book value: To what extent is book value misleading? What adjustments need to be made to properly bring the asset components to fair market value?

Earnings capacity: What is the business future income potential? What adjustments need to be made for salaries, travel and entertainment expenses, non-recurring items, potential legal or tax liabilities? Are there shareholder loans that are disguised dividends because they are really equity rather than debt?

Dividend paying capacity: What do cash flow projections show?

Goodwill: What level of earnings over normal expected return can be reasonably projected?

Sale of stock: Have there been recent sales? At what price? Under what conditions and to whom was the stock sold? Have there been events since the sale that significantly affect the value of the business?

A QUICK REALTY CHECK:
Let’s assume you and your co-owners have knowledge of the relevant facts about the finances of the business. Put two slips of paper in front of each person and ask each co-owner to write the answer to two questions:

(1) What is the most you would pay for the stock – if I owned it?

(2) What is the least you would take for the stock – if I wanted to purchase it from you?

This “bid and asked” price technique will help establish an acceptable price range, or assist everyone in coming to a realistic ball-park figure which may be the average of the hypothetical “bid and asked” prices.

CONCLUSION
Valuation of a business interest is a difficult and uncertain process. Yet, for many purposes, it will be necessary for a business or interest in a business to be valued. In some situations it will be sufficient to obtain a mere guesstimate. For others, particularly where income, estate, or gift tax returns are concerned, a much more defensible, objective, analytical, and thorough process must be used. Purposes must be weighed against costs.

Value is a variable upon which reasonable minds can and will differ. But value must not be determined by a mere flip of the coin or a flippant attitude. The use of careful and thorough appraisals by qualified, independent professionals, documentation, and well-drafted arm’s length restrictive and binding agreements are effective tools in establishing and substantiating values that are fair and equitable to the parties involved, and acceptable to our persuasive on federal and state taxing authorities.

To discuss these or other issues you feel are important to your personal or business security and success, please feel free to call email.

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