- 1. The Business Value is the Business Owner's Most Important Asset
The privately held business is usually the single largest asset of the business owner; the 80/20 rule applies – 80% of the business owner’s wealth resides in the value of the business. Many business owners will devote significant funds (which may be well spent) to manage 20% of their wealth consisting of marketable securities. At the same time, business owners frequently devote few resources to fully understand the value of the business.
The scenario described above is perplexing given that the issues involved with a private business are more complex, an ownership interest in the private business is more risky and is infinitely more difficult to convert to cash compared to a portfolio of marketable securities. Given these financial realities, devoting resources to gain a complete knowledge of the value of the business is a very prudent use of funds.
- 2. To Be Prepared for Unsolicited Offers or Unforeseen Events
Business owners often receive unsolicited offers for their business, and they may not have a solid grasp of the value of the business. Worse yet, a business owner may rely on distorted market information related to value that many times involves vague details related to the terms of the transactions. As a result, a business owner’s opinion of the value of the business may be formed without the benefit of reliable market information and without availability to the details surrounding the transactions.
The death or disability of a business owner may trigger a buy-sell agreement and the need to redeem or sell partial or full interests in the business. To the extent a business has obtained a business valuation on a regular basis, the expectations related to such scenarios are better managed, and consequently better outcomes are realized.
These two scenarios reinforce the proposition that a business owner is well served by having a business valuation prepared on a regular basis; the valuation provides information in the event of unsolicited offers or unforeseen events, putting the business owner on a level playing field when having to make important decisions relative to their most important asset.
- 3. To Be in a Position of Strength When Negotiating a Sale
The sale of the business is frequently the single most important financial transaction in the business owner’s life. Potential buyers for the business are typically savvy investment professionals that purchase businesses as a regular aspect of their line of work. In order to level the playing field, the business owner must be armed with all relevant factors that impact the value of the business.
- 4. To Manage Tax Transactions Efficiently
A well-documented business valuation is frequently an integral component of effective tax planning strategies related to a private business. For example, the income tax characterization of incentives to key executives as capital gains rather than ordinary income may be supported by tax planning structures that rely on sound valuations. The valuation of business interests on a minority interest basis is a commonly used technique that provides reduced estate and gift taxes when minority interests are sold or transferred to family members.
- 5. To Be Armed to Question a Potential Buyer's Valuation
A business owner may be offered a high value for the business to grant an exclusive period during due diligence, thus restricting the owners ability to negotiate with other buyers. In another scenario, the business owner may be offered an unreasonably high price with the caveat that the transaction is to be funded primarily with seller financing, leaving the business owner with virtually all of the risk and no control over the business. Situations such as these illustrate the fact that the business owner needs to be fully armed with all information related to the value of the business needed to negotiate favorable price and terms with a potential buyer.
- 6. To Aid in the Avoidance of Buy-Sell Disputes
For private businesses that have multiple parties that hold equity, the business valuation is a powerful tool to use in the establishment and execution of a buy-sell agreement, minimizing the risk of disputes related to the agreement. During the establishment of the buy-sell agreement the appraiser can play a critical role in assisting legal counsel in defining the level of value (e.g., majority interest basis or minority interest basis), so that the appropriate level of value may be used given the specific event that triggers the buy-sell agreement. An annual valuation sets a precedent for the value of the equity, whereas a single valuation that is prepared at the time a triggering event occurs is more vulnerable to claims of bias.
- 7. To Protect the Value of the Business
A well prepared and reported valuation of the business will highlight weaknesses in the business, providing opportunities for business owners to mitigate weaknesses and prevent further erosion of value. Similarly, threats to the business are also identified in the valuation process, providing an opportunity for the business owner to be proactive in meeting those threats.
- 8. To Enhance the Performance of the Business
An annual valuation of the business may be used as a benchmark to assess the performance of the business in its execution of the corporate strategic plan. A series of annual valuations provides objective information to shareholders so that they may evaluate management and make appropriate changes. An annual valuation also provides clear performance metrics and promotes accountability.
- 9. Third Parties Will Have an Interest in Valuing the Business
Business owners should also be aware that multiple parties will either explicitly or implicitly value the business, whether or not the business owner chooses to engage a business appraiser of their own choosing. Therefore, it makes only good common sense for the business owner to be fully informed as to the value of the business. Potential buyers will make their own determination of the value of the business. When a business owner seeks to secure a business loan, the bank will use its own approach to valuing the business. Finally, whether the business is sold or is left in a business owner’s estate, the Internal Revenue Service will have a vested interest in the valuation of the business, most often at a level that generates additional tax revenue.
- 10. To Obtain the Best Combination of Price and Terms in the Market
A well prepared valuation assists the business owner in understanding the strengths, weaknesses, opportunities and threats of the business. This knowledge provides the business owner the opportunity to accentuate strengths and opportunities as well as mitigate weaknesses and threats, long before a sale process for the business commences, affording the business owner with the foundation to realize the best deal in the market.