Why it’s Vital to Know the Value of Your Business
Would you be surprised to learn that most business owners don’t know the value of their own businesses?
More than half of business owners have never had their company valued and don’t anticipate doing so, research shows, and many believe they don’t need a valuation unless they are planning to sell their company.
This belief can be short-sighted.
The reasons a business owner would choose not to have a valuation done run the gamut – from the assumed costs involved, to not believing it is necessary, to simply not understanding the impact of not doing so.
An accurate business valuation can be a valuable tool in many instances, and overlooking this critical part of your asset portfolio can lead to unintended consequences, both fiscally and personally. Many have faced burdensome taxes and personal animosities over perceived entitlement to a value of a business.
In addition to giving business owners important information about the quality, viability and possibilities about their businesses, business valuations are used for a variety of specific situations:
- Estate, gift and trust planning. A family-owned business is often a significant part of an owner’s net worth. Proper estate planning can help to transfer interests in the family business to the next generation or other designated people. This can save tax dollars as well as assist in the smooth transition of leadership in the business, thereby helping to secure the continued success and profitability of the company for generations to come. Without proper planning, the death of an owner may result in the death of a significant asset. A business valuation can be a means to accomplish the long-term goals of the owner.
- Owner buy/sell agreements. Whenever people go into business together, it is highly advisable that a formal buy/sell agreement be used to outline the process that will take place should an owner or owners decide to leave the business, become incapacitated or die. Part of that process would be the valuation of the business itself, to provide all of the owners with the proper numbers to effectuate a buyout. Having a valuation done on a regular basis provides the owners with the tools they need to plan for these future occurrences and possibly to obtain insurance coverage needed to fund a buyout. Long and costly litigation can result when a buy/sell agreement does not exist or fails to address how to value the business.
- Mergers and acquisitions. When one company buys out another or merges with it, a business valuation is essential to determine the fair price to be paid for this transaction. Having a valuation done could point out the various strengths and weaknesses of both companies and help assess if this is a transaction that is beneficial and cost effective. Having a regular valuation done can also help prospective sellers identify the right time to sell or merge and will provide the buyers with a base from which negotiations can begin.
- Divorce settlements. An ownership interest in a business that was acquired during a marriage is usually an asset subject to division among the parties in a divorce. This can often be one of the most significant assets the divorcing parties own. Therefore, a value needs to be placed on the business so that the parties can determine the distribution of the assets held in the marital estate. Often a business owner does not know the value or guesses at it – which can lead to poor results for one or both sides during a divorce litigation. With a business valuation in hand, the parties can then determine how to divide all of the marital assets.
- Litigation matters. Over the life of a business, there may be times when legal matters are initiated. This could be for a variety of issues, such as shareholder disputes, insurance claims for lost business or possibly eminent domain proceedings. In all of these instances, the value of the business can be an integral part of the litigation. Armed with the knowledge of the value, the litigant can put forth a case based on careful analysis and documentation.
For larger companies, a business valuation would be needed if the company has an employee stock ownership plan (ESOP) or if the company wants to go public in what is known as an initial public offering.
Benjamin Franklin once wrote, “In this world nothing can be said to be certain, except death and taxes.” He wrote this in 1789, and it stands true today.
While death cannot be avoided, proper planning and use of a business valuation can often help alleviate tax burdens while also providing business owners with pertinent information that will assist them in a variety of situations.