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Business Valuation

- Commercial & Manufacturing

 
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Value = Income x Risk

 



"Expert valuation of a closely-held business combines financial and economic analysis into a relevant and quantifiable representation of value. An objective of the valuation process is the translation of complex business valuation theory and terminology into a clear and understandable appraisal."




Who Needs A Business Valuation?
Why Do You Need A Business Valuation?
Two More Critical Points
Business Valuation Theory
About Our Firm


Who Needs A Business Valuation?

If you fit any of the following profiles then you need to initiate a business valuation.

  • You have been solicited by your competition, or by a third party, about your willingness to sell your business,
  • You know it is time to begin serious estate planning,
  • Your strategic business plan indicates that you are to identify, evaluate, and approach targets for acquisition,
  • You are now, or likely will be, involved in a divorce matter.






Why Do You Need A Business Valuation?

The "why" of each of the above profiles is explained below.

If you have been solicited, or otherwise approached in a bona fide manner, about selling your business, you should consider having a business valuation performed. With a formal business value in hand you will have a reference point for making the decision to proceed further with the solicitation and later with the serious negotiations that are involved in selling a business.

Note:

It is imperative that you understand what gives value to your business. You will gain confidence in the conclusion of value when you fully understand the appraiser's valuation approaches and supporting theory. Only then can you prevent the financial sin of "leaving money on the table" when the sale is finalized.

If either your age or your health mandates that you seriously begin estate planning, knowing the fair market value of your business is critical. For most individuals, the value of their closely held business is the largest component of their entire estate. You will be more effective with estate planning knowing you have an accurate value of your business.

Note:

The tax dollars saved from estate tax planning are often quite significant. Stating it another way, the estate taxes due at your death may be so burdensome as to require your heirs to sell equity to outsiders, or in certain instances, to necessitate that the entire company be sold.

If your strategic business plan calls for growth through acquisition, consider obtaining a business valuation of the target entity. You should consider using your company's valuable financial resources only after performing a thorough analysis of the subject entity. The unfortunate fact is that most acquired businesses fail to achieve their expected financial results and are, at the outset, overbought.

Fact:

If you do not know the fair market value, you will not know the bidding point at which you should end negotiations.

In an equitable distribution (i.e. divorce scenario), you must know the value of your business, what portion of the value is included in the marital estate, and how to protect your own interests.

Note:

If your spouse has made inquiries about the value of your business then perhaps it is time you thought along the same lines. In certain instances significant financial resources may be protected by divorce planning.


Two More Critical Points

Get an independent business appraisal. Have someone other than your regular accountant perform the valuation. First, your accountant may not have the specialized training or experience to perform the appraisal. Second, he may be too eager to "agree" with you about your opinion of value, (or may not be able to disagree with you). Simply put, you neither want to "leave money on the table," nor do you need high expectations that will not ever materialize.

Do not reveal your own opinion of your company's value to your appraiser. He will make a professional judgement based on his knowledge and experience and your financial data. It is very interesting to hear his value first!


Business Valuation Theory

What is meant by "Fair Market Value" and what is a "Standard of Value"?

These are fundamental valuation concepts.

Fair market value is the most common standard of value for ownership of a company. A frequently relied upon definition of "fair market value" comes from the Internal Revenue Service's Regulation 20.2031-1(b). That definition is:

The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

Fair Market Value is the price at which a hypothetical sale transaction will occur. It is properly termed a "hypothetical" sale transaction for two significant reasons. First, the sale transaction is an attempt to simulate a "market" and as such does not involve a real buyer or a real seller. Second, the sale transaction assumes and/or implies a number of underlying precedent conditions, which may or may not be present in an actual sale. Hence, the business appraiser's Fair Market Value may or may not be the sale price that an actual sale transaction would derive. The "FMV" hypothetical sale transaction has the following assumptions and/or implications;
  • that the transaction is cash or a cash-equivalent price at existing economic conditions,
  • that the parties are adequately informed of all relevant facts,
  • that there is no compulsion existing upon either party to consummate the transaction,
  • that a covenant not to compete, when appropriate, is included in the price,
  • that the buyer has both the ability to buy and the willingness to buy,
  • that a market composed of potential buyers and sellers of similar businesses exists,
  • that a particular buyer having a specific motive is not contemplated,
  • that a reasonable amount of time is contemplated to achieve the sale price.
What "FMV" in a hypothetical sale scenario doesn't consider are the following "real world" factors;
  1. that a well planned strategy for the sale of a business, effectively implemented, will achieve a higher selling price than the hypothetical price.
  2. that a buyer may not always be aware of all of the relevant factors (i.e. you can hide, or minimize if you cannot hide, the company blemishes, and you can accentuate the positive company features, even "puff" a little here and there)
  3. that a seller with a long-term time horizon will achieve a higher price than the hypothetical price.
  4. that locating a synergistic buyer will, in all likelihood, achieve a higher transaction price.
  5. that the utilization of an experienced negotiator will, in almost all cases, obtain a higher sale price.
  6. that providing seller financing to the buyer may result in an overall higher sale price.
  7. that a consulting contract with the departing owner or key person can add additional value to the realized total price.
  8. that a forecast of earnings may present the company in a more positive earnings light than a historical earnings scenario, and therefore, result in a higher sales price.
  9. that a carefully written contract can protect the seller's ability to achieve the agreed upon sale price.




© 2005 Christopher S. Whitener CPA. All rights reserved.

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