It doesn’t have to be ‘For Sale’ Reasons to determine the value of your business

Let’s get it out of the way at the outset – when business valuation is brought up the first thought that comes to mind is “For Sale.”Indeed, this is a valid reason or a business valuation, and perhaps the most obvious, but it is only one of many possible reasons. A business valuation is a powerful tool for managing your business, large or small. It has many uses and can be a prudent investment in determining the future of your company. A few of the more significant ones are as follows.

Acquisitions.
Many successful companies consider that the best use of surplus cash to be an investment in their own company, which thereby fuels growth. Internally, an investment can be made in fixed and working capital; or alternatively, the owner can look to expand through a merger or acquisition. If the latter, it may be necessary to value not only the seller but also the buyer to facilitate a fair and equitable transaction, especially if stock is exchanged.

Raising capital.
Companies whose value is tied up in intangible rather and tangible assets, or highly leveraged companies may have a more difficult time in raising capital, whatever the purpose. A properly prepared valuation normalizes the financial statements to reflect the company’s true earnings capacity, and it quantifies the value of the intangibles. Whether the source is debt or equity, the valuation is a tool that may make the difference in the transaction.

Performance enhancement.
A valuation typically identifies the strengths and weaknesses of a company, and may go so far as to quantify the impact of its value drivers, or key determinants of value (revenue growth rate, cost of goods and services, fixed costs, fixed capital investment, working capital investment, tax rate, and discount rate). Knowing which value driver has the greatest impact on value allows the business owner to focus on those areas which provide the greatest benefit.

Buy-sell agreements.
A business that has numerous owners may benefit from a valuation if a transfer of ownership is contemplated, and particularly if there is a buy-sell agreement. Buy-sell agreements that don’t specify a means of establishing value often end up in court, and even if the agreement does, it may end up in court anyway if the computed value is totally unreasonable. This may be the case with “book value” or values derived from formulae, which don’t take into account the current state of the economy or industry, or the company outlook. A formal valuation takes these into account and more, and provides the business owners with an objective, independent, supportable view.

Estate planning.
If a company is growing rapidly and a transfer in ownership to heirs is anticipated, a series of minority interest transfers may be desirable. This is a very complex area, the specifics of which are beyond the scope of this article. But transferring interests when the company value is lower than it is expected in the future, and utilizing the legitimate discounts for minority interests, can reduce taxes substantially. If the minority interest transfers are large enough, a valuation may be required to establish and support its fair market value.

Debt restructuring.
Debt forgiven by a creditor, whether outright or in exchange for property—equity for instance—can have tax consequences for the company, above the level of insolvency. Because insolvency is defined as the amount by which the taxpayer’s liabilities exceed the fair market value of the taxpayer’s assets (including goodwill) immediately before the discharge of indebtedness, this becomes a valuation matter, particularly in a troubled company.  Companies with firmer footing may benefit from a valuation in planning for the tax consequences of the restructuring.

Conversions.
Converting a company from a C-corporation status to a Limited Liability Company (LLC) may have tax consequences in if the assets have appreciated significantly. Fair market value is the standard that applies, and thus, a valuation may be useful if not necessary.

Tests of reasonableness.
Occasions may arise in which a valuation is required to establish the reasonableness of a particular action when it relates to federal income tax. Compensation to an owner involving stock or business assets is such an example.  

Divorce settlement.
If a business is among the assets involved in a marital dissolution, one party may be awarded a settlement based upon some standard of value. A valuation will assist in determining the amount to be awarded.

Other.
Again, this list of uses for a business valuation is not all-inclusive. Charitable contributions, company bankruptcy, dissenting minority stockholder issues, are among others. So the next time someone mentions business valuation, you’ll have more to consider than just “For Sale”.