December 23/30, 2019: Volume 35, Issue 13
By Roman Basi
Sure, you’re knowledgeable about the various facets of running a flooring store. But do you really know the worth of your business today?
Knowing the worth of your company can facilitate business decisions, minimize tax burdens and establish a fair value for many purposes—such as when a divorce occurs or when a shareholder seeks to dissolve his or her shares in the company. All these factors can impact a valuation.
Many business people are not familiar with what a valuation is, why they need it and how to get it done. In short, a business valuation is a report written by a qualified appraiser for purposes including business succession, estate and tax planning, litigation, buy-sell situations and other purposes. A business valuation will reflect the value of a business a willing buyer would agree to pay in an arm’s-length transaction. Note: it must be in the form of a written report. Oral reports from a valuator simply will not suffice because buyers, sellers and the IRS will not see much credibility.
There are many misperceptions about valuations. Many business owners believe a successful valuation can be calculated based on simple multiples. For instance, someone is always inquiring as to whether he or she can multiply the gross income or net profit by a certain number based upon some theoretical condition of the business to reach a value conclusion. Neither the IRS nor any potential buyer will accept these multiples as a sound valuation. Two decades of experience and a whole host of IRS letter rulings, memorandums, statutes and cases demand that a simple multiple in determining value cannot be used to arrive at a valid figure.
Furthermore, the valuation must be done by a qualified appraiser. First, the appraiser must be someone who does not have a bias concerning the value of the company. Generally speaking, friends, relatives and employees are excluded from the definition. Also, the company accountant should not conduct the valuation since he or she is not in a position to be objective.
Next, the appraiser must be an expert on the matter. Being a CPA or attorney is simply not enough to certify a person as a qualified appraiser. The appraiser must have the experience and training in both the areas of valuation and in the industry in question. The IRS and the courts will disqualify individuals who try to value companies when the appraiser doesn’t know or understand the industry.
There are different situations that require a valuation. For example: When the owner of a business transfers an interest in a company, either as a gift or at death, the IRS requires a valuation to be done in order to access the proper estate and gift taxes. Valuations are also required when drafting buy-sell agreements. These are used in businesses to provide for liquidating the interest of a withdrawing or deceased shareholder. Other situations that call for business valuations include: the implementation of employee stock ownership programs; mergers and acquisitions; and divorce settlements. In the latter case, the value of the business itself is required for a property settlement. Sometimes both parties will agree to an independent appraiser. More commonly, however, the parties will each hire their own experts and the matter will either be settled or decided in a court of law.
Bottom line: In the business world, not knowing the value of a business can translate into the loss of a lifetime of work in value and dollars. Don’t wait—you could be putting yourself at a major disadvantage.
Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners. For more information, please visit taxplanning.com.