While the value of each share in a publicly traded company is typically known, the value of an ownership interest in a privately held business is not so readily obtainable. When the value of an interest in a privately held business is needed, an independent business valuation prepared by a qualified valuation professional may be necessary.
A business valuation is the process of determining the economic value of a company, and it includes using generally accepted valuation approaches and methodologies. There are three generally accepted business valuation approaches (the asset, income, and market approaches) and various recognized methodologies (such as the discounted cash flow or completed transaction comparable company methods) under each approach.
The list of reasons to get a business valuation is long and it includes both business and personal motivations. On the business side, a business valuation may be an element of strategic planning, utilized to identify value drivers, required for purposes of obtaining bank financing or insurance coverage, or used when evaluating potential mergers and acquisitions. Personal reasons generally relate to tax or litigation matters. When obtained retrospectively, valuations can help business owners successfully navigate the situation at hand. When obtained prospectively, an up-to-date valuation can help business owners prepare for unforeseen circumstances or take advantage of sudden opportunities. Ultimately, a business valuation report is a vital tool used to help business owners make informed decisions and manage business issues and personal events, whether foreseen or not.
Here are five reasons to get a business valuation.
Mergers and Acquisitions
On top of the actual estimate of business value, a business valuation provides the business owner with a lot of additional information about the business and its operations and position in the marketplace. Business valuation professionals put themselves in the shoes of sophisticated investors in the marketplace to evaluate returns the business can generate in the context of the riskiness of those returns. If the company has a history of obtaining business valuations, a business owner will be able to quickly evaluate any third-party offers to purchase the business. Moreover, if part of your growth strategy includes buying other companies, a business valuation will help you determine if the price you are being asked to pay is reasonable.
Succession Planning
When planning for the future of the company after their eventual exit, business owners have many transition options. The most common options for succession include transferring ownership interests to family members, selling shares to key (or to all) employees (see ESOPs below), or selling shares to unrelated third parties or competitors. To ensure that the business is sold or transferred for a proper amount, a business valuation is essential to inform one or both parties. Also, if you are planning to transfer your business, obtaining a current business valuation helps set a baseline value for the business, which can be used to develop a strategy to grow the business or improve profitability to increase value before an exit.
Estate and Gift Tax
For federal tax law purposes, estate and gift taxes are often considered together because they are subject to the same rate and share the lifetime exemption amount. Further, the impact of estate and gift taxes on planning strategies must be constantly monitored and evaluated as both the tax rates and exemption amounts change from year-to-year. Obtaining a business valuation facilitates strategic estate and gift tax planning as it helps you understand the value of the assets and any potential tax liabilities that would apply upon transfer. When evaluating the specific ownership interest, discounts for the lack of control and lack of marketability may be important considerations.
Marital Dissolution
When one or both parties in a divorce have an ownership interest in a privately held business, the value of that business interest needs to be determined for purposes of property division. If the parties are amicable and can agree on the value of the ownership interest, a business valuation may not be needed. Many times during divorce proceedings, however, the value of the business is a major source of disagreement because the business is a significant portion of the parties’ marital estate and a major source of the family’s income. An independent business valuation can be used for purposes of preliminary settlement negotiations or for trial purposes as part of expert witness testimony.
Employee Incentives & Ownership
To align the interests of employees with those of business owners or to attract top-tier talent, business owners and managers may consider using ownership interests in the business to compensate employees. Business interests are a form of non-cash compensation when granted to employees and certain tax rules apply to their use as compensation. Businesses can grant bonuses linked to its value (synthetic equity) or grant shares, interests, or options to purchase conventional equity in the company. Oftentimes at the time of the grant and to settle the equity plan in cash, a business valuation is needed to ensure the equity compensation plan results in desired economic outcomes, proper tax treatment, and compliance with tax and other laws.
Another form of employee ownership in which business valuations are needed on a recurring basis is the employee stock ownership plan (ESOP). An ESOP is an employee retirement benefit plan that owns and allocates shares to eligible employees for such employees’ benefit. An ESOP is usually formed in a closely held company to facilitate ownership succession and gives employees an effective ownership interest in the business. ESOPs provide those who sell to it, sponsoring corporations, and participants with various tax benefits, making them qualified plans. To comply with laws, regulations, and Department of Labor and Internal Revenue Service requirements, business valuations are needed at various stages of an ESOP’s life. The shares held by the ESOP must be valued annually to determine the value of the shares in participant accounts, and the ESOP generally needs to obtain independent valuation advisory services whenever it enters into transactions to purchase shares. Sellers contemplating a sale to an ESOP also typically obtain valuations to assist in planning and structuring the transaction.
Helping You Get There
These are only a few of the many potential reasons to have your business valued. Boulay has a team of dedicated professionals with specialized business valuation credentials and years of valuation experience who are ready to assist you with your needs. Contact us today, and our valuation team will schedule a consultation to discuss your needs.