Many business owners assume the only right time to have their companies appraised is when they’re ready to sell. Not so. There are, in fact, many “right times” to engage the services of a professional appraiser.
Setting your strategy
Indeed, whether you’ve decided to sell or are just considering it, an appraisal is key. Many business owners fail to consider whether they’re sacrificing significant investment income by continuing to hold equity in their companies. An appraiser can determine the price you’ll need to sell for, so that the after-tax return on the invested sales proceeds will equal — or exceed — your current take-home pay.
A variation on an outright sale that many business owners have undertaken in recent years is establishing an employee stock ownership plan (ESOP). One part qualified retirement plan and another part profit-sharing plan, these arrangements allow employees to own part of the company that employs them. They may then cash in their shares when they retire or otherwise leave the business.
Among the many rules governing ESOPs is that plan sponsors must obtain regular business valuations to ensure the ESOP pays no more than fair market value for shares of the company in question. Failing to comply with these rules could subject the business to substantial excise taxes as well as potentially lead to litigation by disgruntled participants.
Business sales aside, there are other reasons to regularly get an appraisal. The process can enable you to identify your company’s key value drivers, assess its strengths and weaknesses, and track progress toward major objectives. If you’re seeking outside financing, a valuation can also help establish creditworthiness. Also, some business owners just want to know what their companies are worth.
Planning for the future
Business appraisals also provide estate planning benefits. For example, if you’re creating or updating your estate plan, your company’s value affects the tax-related costs of selling, gifting or bequeathing your interests in the business. Failing to estimate value properly may leave your heirs with a sizable estate tax bill that could force them to sell the company after your death.
From a succession planning perspective, business owners who regularly obtain updated business appraisals are better prepared to handle unexpected events. If a key family member suddenly dies or becomes disabled, for instance, a valid buy-sell agreement combined with a timely valuation can expedite the shareholder buyout, providing much-needed cash flow to family members and minimizing business interruptions.
Anticipating the process
As you can see, there are many situations that may warrant an appraisal. If you decide to obtain one, expect your valuator to apply one of three methods — or a combination thereof.
For asset-intensive companies and distressed businesses considering liquidation, the cost approach is often used. Here business value is the difference between the market value of assets and liabilities.
Another option is the income approach. In this case, the appraiser converts a company’s expected income stream into its present value using either a capitalization or discount rate. In other words, value is a function of future earnings and the risk associated with the likelihood of achieving those earnings.
The third common method is the market approach, under which value is based on comparable public or private transactions. For the former, valuators often apply the guideline public company method, whereby pricing multiples — such as price-to-revenues or price-to-earnings — come from public stock data reported to the SEC. In the case of a privately held company, appraisers commonly apply the merger and acquisition method based on private business transactions, which are compiled by various proprietary databases.
When selecting the appropriate method or methods, an appraiser will consider your business type, the valuation’s purpose, the availability of data and what’s typical in your industry. Other critical factors may include personal vs. business goodwill, intangible value and company-specific risk.
Getting the info
To be clear, a business appraisal is hardly a casual undertaking. You’ll need to invest in a qualified appraiser and spend some time and energy helping this expert gather the necessary documentation. Nonetheless, under the right circumstances — and there are many — a valuation can deliver critical decision-making information.