The value of a private company is essential to its operations and long-term sustainability. And under a wide variety of cases, business valuations are needed and necessary. These circumstances may include the following:
- Selling of a business (including a retirement exit strategy)
- The purchase of a business
- A potential merging of businesses
- The procurement of additional financing
- The dissolution of the business
- The withdrawal of one or more partners or shareholders from the business
- The resolution of personal or family issues, such as a divorce proceeding
- Estate and tax planning purposes
The fact that one or more of these problems are likely to occur at any point in time, an up-to-date valuation of the company should be available to any business owner. It’s like staying up to date with your resume, just in case.
Here are some of the biggest reasons why you need a business valuation:
1. It’s an Art and a Science
Valuing a business is as much an art as it is a science. As one analyst has put it, “how much the business is worth depends on who asks and why.” In this comprehensive guide, we will discuss the differences in valuation methodologies and we will also elaborate on the reasons for conducting the valuations.
Furthermore, it’s important to have a fair and supportable asking price for those owners selling a business. The opportunity for a sale is compromised by proposing an unreasonably high price tag on a business. Indeed, one organization suggests that the most important reason that certain small companies do not sell or do not sell quickly is that they are drastically overpriced.
For potential buyers, an authoritative valuation provides support for the offer they are making, and can also help in obtaining financing to make the purchase. Many lenders will require a business valuation before approving a loan for acquiring a business.
2. Valuations in Buy-Sell Agreements
The dissolution of a company, or the separation from the business of one or more owners, may create possible issues with how much the departing owner gets after leaving the business. Many businesses with two or more owners sign a buy-sell agreement to prevent or mitigate this issue, which allows for the business or other shareholders to buy the interests of the owner who leaves. A buy-sell agreement will include a valuation agreement that either sets a fixed price or provides a price calculation formula that will be obtained by the person leaving the company.
For example, some agreements contain a provision that the departing individual will receive “the fair market value of the shares as determined by a qualified business appraiser.”
3. Valuations in a Divorce
Since such a large proportion of marriages end in divorce, a large number of business valuations are carried out in order to split the company’s assets among the divorcing parties equitably. These valuations are carried out in order to determine the company’s fair market value. Expert testimony may sometimes be required if a settlement can not be established by the parties.
A spouse who does not partake in the operation of the company frequently assumes that the company is worth more than the other spouse does, and the gaps between the two conceptions may often be very wide. Usually, family court judges do not have substantial business appraisal experience, so it would always be prudent for the operating spouse to hire a good business appraiser to make a reasonable judgment, one that will make the judge a convincing argument.
The valuation is often complicated by the fact that most states distinguish between two types of value in a business:
- “Enterprise goodwill” reflects the value of the business itself, and is deemed to be transferable to another party.
- “Personal goodwill” arises from the talents and efforts of the spouse who actually operates the business. In a divorce, the enterprise goodwill is considered part of the marital estate, while the personal goodwill is excluded from the estate.
This division of the value of the business can have a significant effect on the division of the business as between the two divorcing spouses.
4. Taxes and Estate Planning
For tax and estate planning purposes, valuations are often made. For estate planning, in order to provide sufficient funds for a potential estate tax liability, it is essential for the business owner to have an accurate valuation. When a business owner dies, providing a precise assessment of the company’s value can be critically valuable to his or her heirs.
Getting an accurate estimate of the value of the business will assist the owner in arranging liquidity to meet the estate tax obligation (typically via a life insurance policy). However, by gifting ownership shares in the company to the probable heirs while the owner is still alive, the owner may be able to counteract or prevent the estate tax liability.
5. Some Additional Times When Valuations are Needed
We’ve covered most of the major times when valuations are required. There are a number of other issues that will trigger the need for a valuation. Most of these have to do with raising capital.
For example, if a small public company has not developed a liquid market, the major shareholders may wish to go private in order to eliminate the need and expense of reporting, and other requirements of being a public company.
Note: A fair price must be offered to minority shareholders, and a formal valuation process will help ensure that this occurs.
The Bottom Line
Valuations are subject to a variety of calculations, some of which do not necessarily coincide with each other. And depending on the particular reason for the valuation, one or another of the many valuation methodologies may be used.
For example, when you’re selling your business, you would like the valuation to be higher rather than lower so that the bidding would start as high as reasonably possible.
Conversely, if you’re contemplating buying a business, you would prefer that the valuation be somewhat lower. In that case, perhaps you should not rely on the valuation put forward by the selling firm, but rather you should hire your own valuation expert.
Nevertheless, there is a good reason why the buyer’s valuation should not be too low. A higher valuation makes a lender more comfortable in providing financing since it provides greater collateral for making the loan.
Choose Bankers Advocate
Prominently, certified business valuations are a necessary aspect of running a business – business cannot be conducted over any reasonable period of time without such valuations. For this reason, it is always a good idea to have an up-to-date and accurate assessment of the worth of your business handy.
A valuation conducted by a qualified valuation specialist in Bankers Advocate offers the best way to ensure that you, your partners, your spouse, your heirs and other interested parties have the most accurate information about the business.