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As a business owner, a business valuation should be the starting point of your exit planning.
Yes, it’s just a number, a number that an objective third party believes that your business is worth at a specific point in time. But with a few tweaks and in the right hands it can be a gold mine of information.
With our knowledge and experience, we can uniquely use it to advise you on not only wealth planning, tax planning, estate planning, and exit planning, but we can also work with you so that over time, your business will reach its maximum market value.
Different advisors will offer opinions that produce different answers. You – the business owner, your CPA, your attorney, a potential buyer and their advisors, and especially the IRS may end up with wildly different values of what the business is worth. The IRS? Yes – don’t forget the IRS will review every business transfer - looking for even more taxes from you!
Why Will the Valuation of Different Advisors be Different?
The purpose of the valuation will have a big impact on the results. Some valuation authorities require or advocate specific valuation approaches depending on the purpose of the valuation. For example, The IRS is the governing valuation authority for taxes. They require valuators to use the IRC 59-60 standards.
There are different “Standards of Value” depending on the purpose of the valuation.
HERE ARE A FEW:
FAIR MARKET VALUE
The fair market value method necessary for all tax related (IRS scrutiny) transactions involving related parties – key employee or management buyouts and family transactions. This valuation method seeks to define what a willing buyer would pay a willing seller in the market place. Without the fair market value standard, the IRS believes business owners would be too tempted to claim their business was worth very little to minimize transfer costs and taxes.
Investment Value is the value of a business to a specific investor. This could be another company, a wealthy individual or a professional investment company. The valuation figure depends on the buyer’s specific investment requirements and expectations - for example, an investment company that is simply looking for a financial return.
Liquidation Value assumes the business is no longer viable and there is more to be gained by selling the company’s assets piecemeal rather than as a whole. Timing is critical. If the seller can liquidate the company’s assets quickly they are worth more. The Liquidation Value standard is not appropriate for most companies and most situations.
RULES OF THUMB OR INDUSTRY FORMULA
Important – Please Read - Rules of Thumb or Industry Formula are NOT a valuation “Standard of Value” but deserve special mention as a valuation process. As a Business Owner you will almost certainly hear various advisors talk about your company value being a multiple of revenues/earnings or that companies in your industry usually sell for an amount based on some sort of simple calculation or formula. These individuals are just repeating formulas based on industry Rules-of-Thumb. Business Brokers often price their clients companies for sale based on these formulas.
CAUTION – We have reviewed countless estate plans and Buy/Sell agreements that use a full page of revenue and earnings calculations or call for one or more CPAs to place a value on the business – and then take the average or median or whatever. This is a MAJOR Issue. The IRS would put a red X through these valuation methods and put their own “Reasonable” (read as high as they can realistically support) value on your business so you pay as much tax as possible.
The IRS will review any transaction involving the transfer of any shares of stock or assets of the business with a fine tooth comb. If the transaction does not use the value as determined by an independent, third party certified valuation, the IRS will value the business on their own and you’ll be in the difficult position of trying to show their number is not reasonable.
Can you avoid this situation? Yes! Strike first and put the burden of disproving the number with the IRS. Remember, it’s not just about coming up with another value for the business. Instead the IRS would have to show the value as determined by the independent valuation was not reasonable – a very difficult level of burden of proof.
Requirements for a Valuation Acceptable to the IRS (or in court).
You may think that no one knows the value of your business better than you, or your CPA, or your attorney or other trusted advisor. Understandably, the IRS and the courts may be suspect of a value derived by a related party and not give much credibility to any value not derived by third party, independent and accredited valuation professional.
In fact, the IRS requires that all valuations be conducted by a qualified appraiser. To meet this IRS requirement, the value of the business should be determined by an independent, third party, properly qualified valuation professional.
Usually this means a valuator must have a credential issued by one of these four organizations: The National Association of Certified Valuation Analysts (NACVA), The American Institute of Certified Public Accountants (AICPA – the certification is NOT a CPA), The American Society of Appraisers (ASA) or The Institute of Business Appraisers (IBA).
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We are business transition specialists. We help owners, family members, and advisors evaluate exit and succession options and implement plans to successfully transition businesses.
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Fox lake, IL, 60020
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