Reasons Why You May Need Your Business Valued
July 19, 2023
By Jeff Allen, originally published in SBAM’s May/June 2023 issue of Focus magazine
So, you’re a successful business owner. Congratulations! However, after years of growing your business, new challenges most likely lie ahead. Maybe getting older is making you think of retirement, a partner has grown restless with the current setup or an amazing financing opportunity has come along, allowing for growth. Whatever the reason, business owners often face the reality of having their business valued.
In fact, there are many reasons why you may need a business valuation:
Business Sale: It goes without saying when most people think of a business valuation, they are thinking about what a business will cost to purchase or the price to be paid to acquire it. A well-prepared business valuation will provide insight into the various reasons that underline the value arrived at by the analyst.
Many assume you take an earnings number, multiply it by some magical number and determine the value of a business. While earnings multiples can indeed be a factor in determining value, there are often many other critical aspects of the business to evaluate. Included in the “earnings” number could be several inappropriate items. The business may be operating much differently than its peers who apply the same multiple. A good valuation analyst can dig deep into the weeds and provide exceptional insight into why the business is worth a certain amount.
Estate and Gift Tax: You’ve finally built your empire and profits and cash flow are amazing. One problem—you’re getting up there in age and can’t keep building the company like you did in your younger years. It’s time to face the inevitable and make decisions about the future.
Rather than selling to a stranger, transferring ownership to the next generation of the family may seem more appealing. Unfortunately, the Internal Revenue Service (IRS) doesn’t allow you to just “give away” the business to your family members. A business valuation is often required to properly gift ownership shares to others. Teamed with an exceptional tax advisor, the IRS can be satisfied, and taxes may be mitigated.
Buy-Sell Agreements: Many professional firms (physicians, lawyers, accountants, engineers, architects, etc.) promise promotions to up-and-coming staff. Many talented workers are eventually faced with the prospect of becoming a partner with the ability to “buy in” to the firm. But how much should they pay? Likewise, when it’s time to retire and sell shares in the firm, how much should the retiring partner receive? Questions like these can often be answered in a well-written buy-sell agreement. Many times, these agreements call for a formal business valuation or calculation of value.
Divorce: After 25 years of marriage, the world’s wealthiest couple, Jeff and MacKenzie Bezos called it quits in 2019. The estimated net worth of the couple at the time was $153.1 billion dollars representing 16 percent of the shares of Amazon.
While it’s unexpected that many of us would ever need to determine how to divide this vast of a fortune, the truth remains for some that divorce may be imminent, and assets will need to be valued to determine who gets what and how much. If shares in a closely-held business are owned by one of the spouses, a business valuation will likely be required by the court.
Litigation: Like it or not, lawsuits exist, and sometimes we need professionals to assist. When a business has been harmed unfairly or when a minority shareholder has potentially been stepped on by a majority shareholder, a lawsuit often arises. Business valuations are often called for to determine damages or buy-out prices.
Loans: Ever heard of a debt covenant? It’s a fancy term used in the banking industry that basically allows a bank to lend to a business if some sort of ratio(s) is(are) maintained while the debt remains outstanding. While some covenant requirements are straightforward, others may be more complex. Some lenders, especially if the Small Business Administration is involved, may require a business valuation. Critical financing for future growth may be obtained with a proper business valuation.
Determining Strengths and Weaknesses: Many assume a business valuation is nothing more than a calculation that spits out a number (hopefully a really big one!). However, the valuation process is an extremely in-depth ordeal that examines a company’s strengths and weaknesses, comparisons to industry peers, evaluation of management bench strength, workforce evaluation, leverage, excess owner compensation and non-operating assets or liabilities that are inside the business entity.
A proper business valuation, while delivering value, can also be used to learn other traits about the business and provide insight for ownership and management regarding matters such as these.