Business Valuations

Business Valuations

By Lance Wallach

     Business owners may face a number of issues when confronted with the death, disability, or retirement of an employee, partner, or shareholder.  Some of the dilemmas they face may include paying off business debts, having sufficient funds to pay estate taxes, leaving behind a stable operating business, and preserving the value of the business assets for heirs or family members.  A business valuation can begin the process of helping to solve each of these problems.

     When a business owner dies, retires, or becomes disabled, the heirs, partners or remaining shareholders obviously have to either liquidate the business or continue its operations.  Each option has its own set of parameters that can seriously affect the remaining parties.  Liquidation may be necessary to pay obligations such as business debts, guarantees, or estate taxes.  It may also be necessary if there is not enough working capital to continue operations. If the business ceases to exist, the liquidation value may be substantially less than the going concern value.   Not to mention that employees will lose their jobs.

     In the case of a partnership, if the partnership ceases to exist the liquidation value likewise may be far less than the going concern value.  When a partner retires, dies, or becomes disabled, the partnership may be required to dissolve and liquidate all assets, unless the partnership agreement provides otherwise.  The affected families will lose any income from the partnership, and employees and remaining partners could lose their jobs and possibly their investments.

     Continuing the business should be an option.  The heirs may attempt to continue the business or operate it until a buyer is found.  The deceased’s executor may be personally responsible for any operating losses and may not want to accept this risk.  The heirs may not be capable of doing the same job or may not get along with the remaining partners.  Their goals may conflict with those of the surviving partners.  Additionally, current operating capital may be insufficient to continue the business with all of the other funds necessary at death.  Selling out to a key employee, partner, or shareholder may be a logical choice and an effective method for everyone concerned.  But what will be the purchase price?  Can the other party afford to buy the business?  Where will the money come from?

     There are many methods to estimate the value of a business.  The potential solutions for problems caused by death, disability, or retirement may depend upon the proper value of the business.  After the value has been determined, the owner(s) may proceed in planning for the disposition of the business.  Determining the value of a business is an art.  There are no fixed rules, just general guidelines.  All characteristics of the business must be considered.  The value, however, is ultimately what a buyer will pay considering all relevant circumstances and bargaining at arms length.  This is referred to as the fair market value.

     Agreed Value:  The parties agree on a stated value.  This approach must be realistic and updated periodically.  An important element here is that the buyer and seller presumably have opposing interests; therefore, any price they agree on should represent fair market value.

     Appraised Value:  determined by a qualified appraiser, this option can be expensive, but it may be the value that is most likely to be respected by all parties.  In other words, the more expertise that is involved in determining the value, the more accurate the final determination may be.  Sometimes the parties or appraiser will base the value on a formula.

     Valuation Formulas:  There are numerous potential valuation formulas, but regardless of the method used, two points remain important.  First, the general factors considered by the IRS are still basic guidelines used for determining the value of a business for estate tax purposes.  Second, the particular nature of a business must be considered to determine which facets are the most important in valuing that business.  A mechanical application of the various methods may not be sufficient.  Lastly, the IRS may carefully scrutinize buy/sell agreements between family members.  In these situations, it is important that the value used be an accurate reflection of the value of the business.  If not, the IRS may not accept the value for estate or gift tax purposes.  This may result in more tax being due than originally planned. 

     Lance Wallach, CLU, ChFC, CIMC, speaks at more than 70 national conventions annually and writes for more than 50 national publications.  He can be contacted by calling (516) 938-5007 or through www.vebaplan.com

     The information provided herein is not intended as legal, accounting, financial, or any other type of advice for any specific individual or other entity.  You should contact an appropriate professional for any such advice.