Five Things Business Owners Should Know About Business Valuation
- Not all value is the same:
In the real world value is a range, and not all values are the same. It is important to understand the type of value used in a report and consider whether it is suitable for the purpose that you intend. For example, if you are gifting an interest in a company, you MUST use the fair market value standard of value; the IRS will not accept any other in support of a gift value. Below are the definitions of some of the more commonly used types or standards of value.
- Fair market value - defined in Revenue Ruling 59-60 as follows:
The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
- Insurance value - the value of the insurable interest of a particular asset or group of assets.
- Investment (Synergistic) value - the value to a particular investor based on individual investment requirements and expectations, as defined in the International Glossary of Business Valuation Terms, June 8, 2001.
- Fair value - defined in Florida Statute 607.1301 as follows:
Fair Value means the value of the corporation’s shares determined: (a) Immediately before the effectuation of the corporate action to which the shareholder objects. (b)Using customary and current calculation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable to the corporation and its remaining shareholders. (c) For a corporation with 10 or fewer shareholders, without discounting for lack of marketability or minority status.
One final differentiation: Price does NOT equal value. What you could actually sell a business for may or may not equal any of the values arrived at in a particular valuation assignment. In the case of a sale, the price will be determined by a negotiation between a buyer and a seller based on the specific goals and objectives of each party. There are often non-financial objectives that come into play in an actual sale are specific to the actual transaction.
- The purpose of a report can determine the type of report:
There may be requirements by the authorities that oversee the use of the report that will influence the type of value used. Below are the authorities that establish the rules related to valuations for the identified purposes.
- Gift or estate - Internal Revenue Code and related regulations, as well as the Tax Court
- Buy-sell agreement - This is a contractual relationship which will reflect the intentions of the shareholders and enforced through the appropriate legal jurisdiction.
- Merger and Acquisition - Investment bankers typically broker mergers and acquisitions and therefore set the standards with regard to the criteria for these transactions as gatekeepers.
- Divorce - Family law courts in each state defines value in statute and through case law. Different states will call the value by different names including fair market value, market value and divorce value.
- Shareholder litigation - Each state defines fair value in statute and through case law.
- Who should advise you regarding value
? In selecting a business appraiser it is important to look into the qualifications and credentials of the appraiser. There is no requirement in Florida that a business appraiser be certified or licensed. However, members of appraisal societies must comply with the ethics and standards of those societies. Business brokers will often tell a business owner what he or she thinks a business is worth. These types of assessments are often appropriate to give a business owner an idea of what his business could possibly sell for. However, this oral value assessment is not appropriate for all purposes. It is important to make sure that the selected appraiser can deliver a report in the form and following the standards that are appropriate for the identified purpose.
- Business appraisers
- ABV - Accredited in Business Valuation, American Institute of CPAs (http://www.aicpa.org/accrspec/specdesg.htm)
- CBA - Certified Business Appraiser, Institute of Business Appraisers (http://www.go-iba.com/certify.asp)
- ASA - Accredited Senior Appraiser, American Society of Appraisers (http://www.bvappraisers.org/why_hire/)
- CVA - Certified Valuation Analyst, National Association of Certified Valuation Analysts (http://www.nacva.com/certifications/n_certify.html)
- CFA - Certified Financial Analyst
- Business broker - may be independent or a member of the International Business Brokers Association
- Factors which can affect the price you pay for a valuation
- As discussed, the purpose of a report has a direct impact on the report. The use of the report can also have an impact on the professional liability exposure of the business appraiser. For example, a report to be used as part of an initial public offering has a much higher risk of liability associated with it compared to a report to be used in a divorce proceeding. Additionally, the quality of the information available can also be a major factor in the price of a report. A business with excellent books and records in a well established industry will be less expensive to value than a similar business in a unique industry with poorly kept records. Some of the factors which impact the price of a valuation engagement include: the purpose of the report, the type of report, the organizational structure, the capital structure, the industry, the uniqueness of business, the condition of accounting records and the quality of projections supplied by management.
- Factors which may affect the final opinion of value
- If the owner of a business is preparing to transfer all or part of the company, he or she should keep in mind that there are steps that can be taken maximize or minimize the value of a business. For example a company with no succession planning, poor business records and unrecorded revenue may have a depressed price. A business owner may want to get clean up business records, make sure all transactions are recorded and have contracts for key employees in place before trying to sell a business to maximize value. On the other hand, it may make sense to value a business for gifting purposes before upgrading a company's computer and accounting systems and prior to reorganizing to increase efficiency. However, the business appraiser must consider all known or knowable facts as of the valuation date, so make plans to gift before you make plans that will increase the value of the business. .
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