Succession Plans Often Hinge on Reliable Valuation
The “fair market value” of a business is a price that is acceptable to a willing buyer and seller, neither of whom is under any compulsion to complete the transaction, and with both parties having reasonable knowledge of the relevant facts. Still, lenders generally require a professional valuation (or appraisal) before extending credit to business owners or buyers.
Even if a loan or sale is not in your immediate plans, a precise valuation may be useful for effective succession, tax, and retirement planning.
Three Ways to Determine Value
A professional accountant or business appraiser may employ one or more of the following methods when assessing a firm’s value, depending on the nature of the business and other relevant factors.
Asset-based approach (also known as cost approach). Considers the fair market value of fixed assets and equipment and the wholesale value of current inventory, minus any liabilities.
Market approach. Compares the business to similar enterprises that have sold recently, adjusting for differences in size, risk, market position, and other characteristics.
Income approach. Calculates a value based on the company’s ability to earn income. Basically, the average earnings over a certain period of time are divided by a capitalization rate that typically applies to the specific industry.
The value is often expressed as a multiple of net income or revenue. Because many variables can influence how much a business may be worth, the resulting estimates are often fairly subjective.
Making Informed Decisions
Here are a few situations in which you might need to know the current value of your business.
- If your firm has more than one owner and you have negotiated a buy-sell agreement, the buyout value should be updated regularly to reflect market conditions and the company’s financial position.
- When transferring ownership of a family business to the next generation, an accurate valuation may help ensure that partnership shares conform to the IRS annual gift tax exclusion (currently $15,000 per person, per year).
- In the event of a divorce or other type of legal dispute, a professional valuation may help you negotiate a settlement or support litigation.
- Finally, understanding the true market value of your business may help you make more informed decisions about how much of your income should be saved and invested for retirement.