This is a thought leadership article by North American member firm Smith Schafer & Associates discussing the top ten reasons for a business valuation. 

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Most business owners are reactive when it comes to having their businesses valued. But there are many times it pays to be proactive. Some valuations are necessities, such as for determining the value of the business interest in an estate. Others are obtained for more elective reasons but help business owners nevertheless and help business owners with planning strategies. 

It is a good idea to review these common valuation scenarios, so you can identify when it is time to obtain your own valuation. Below are 10 reasons to have your business or a business interest valued.


1. SUCCESSION PLANNING

  • Business succession transactions may be accomplished by gifting the ownership to family. Gifting is most common with family successions.
  • The business may be sold to employees, third parties, or may be combined with some amount of gifting. This type of transfer of ownership will be based on the value determined when the business is valued on an as-is, on-going basis.
  • Businesses may be sold to a strategic buyer (someone in the industry). A transaction with a strategic buyer usually occurs at a value higher than the amount determined with for a traditional transfer to family, employees or an individual buyer with no other connections to the industry. The buyer may incorporate the revenue streams into their existing business and will be able to achieve increased profit and cash flow by consolidating specific overhead expenses.

Example: Two facilities may not be needed, and common business functions, such as administrative may be consolidated and the costs may be eliminated. A specific valuation engagement may be performed to determine an estimated value of the business if it is sold to a strategic buyer.


2. ESTATE & GIFT TAX

  • You might need a business valuation to file an estate tax return and provide guidance to the personal representative to fulfill the terms of the decedent's will.
  • As long as the federal (and some state) estate tax remains in place, it is likely that affecting a gift to minimize ultimate estate tax will require the valuation of a business or a business interest.

3. SALES, MERGERS & ACQUISITIONS

  • A valuation is typically performed when a company acquires another company, is targeted for an acquisition, reorganizes its capital structure, splits up, or files for bankruptcy while in liquidation or reorganization.
  • A merger generally requires both parties to get a valuation, while in an acquisition, it may only be one party.
  • These valuations may create challenges, which require the valuation analyst to calculate cash equivalents for payment (i.e. stock versus cash).

4. BUY/SELL AGREEMENTS

  • A valuation may be necessary for a business to develop a buy/sell agreement. These agreements can serve tax or business purposes. If a sale involves related parties, a valuation might be necessary to ensure a proper value for estate and gift tax purposes.
  • buy/sell agreement allows an owner in a closely-held business to acquire another owner's interest in the event another owner decides to retire, exit, or passes away.
  • These agreements often include a designated price or formula to determine the price the remaining owners would pay to acquire the exiting owner's interest.
  • A valuation analyst should occasionally review this price or formula to keep up to date with the company's performance over time.

5. SHAREHOLDER & PARTNERSHIP BUYOUTS/DISPUTES

  • Ownership disputes result from many different circumstances, including disagreements between owners, conflict with a merger or dissolution, or other related issues.
  • Many states allow businesses to merge, dissolve, or restructure without a unanimous ownership consent.  This may result in a dispute that requires a valuation as part of the settlement process.

6. ALLOCATION OF PURCHASE PRICE (TAX & FINANCIAL REPORTING)

  • In the event of a business transaction (i.e., merger, acquisition, sale, etc.), the purchaser and the seller need to record the sale correctly.
  • Inconsistent and inappropriate allocation of the purchase price may increase tax liability and even penalties.
  • A valuation analyst will consider the differences in business goodwill over personal goodwill and the various state laws applying these transactions and calculations.

7. MARITAL DISSOLUTION (DIVORCE)

  • When a private business owner gets divorced, a valuation may be required to divide the marital estate. Often both sides obtain separate valuations, but there is also a movement toward collaborative divorces in which the parties agree to hire a single valuation analyst.

8. INSURANCE PURPOSES

  • Closely-held business owners will sometimes pursue a valuation to determine a value necessary to cover their business interest value if something were to happen to them. This value is then purchased as “key person insurance.”
  • If something happens, the insurance could payout value to the owner’s family to allow them to continue the owner’s role, or buy themselves out of the owner’s role. These rules are subject to buy/sell agreements and terms within the key person insurance policy.

9. FINANCING/SBA LOAN

  • Financial institutions and the SBA may require a business valuation to underwrite and approve a loan, especially when they acquire a business or a business interest.
  • Typically, financial statements are presented at historical cost.  A valuation will provide the bank with fair market value amounts that can support a loan.

10. ESOP

  • An employee stock ownership plan (ESOP) is an employee benefit plan that invests in employer common stock. ESOPs provide capital, liquidity, and certain tax advantages to those private businesses whose owners do not wish to go public.
  • A valuation must be performed annually for an ESOP. This valuation determines the price per share for the beneficiaries of the ESOP plan. It is a significant valuation because the ESOP trustees may be held personally liable if a beneficiary receives less than the stock's fair market value.
  • This is required to comply with IRS and Department of Labor rules.

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Smith Schafer & Associates, Ltd.

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