\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Your 65-year-old business owner client walks into your office and says he’s ready to start planning his retirement. Finally, he’s open to discussing the ideas and concepts you’ve been advocating for years: succession, taxes, estate plans, due diligence. Most likely, as an attorney, you’re well equipped to guide him through this process.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0But as the conversation progresses, one question will inevitably pop up: “What is my business worth?”
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0It’s tempting to answer with observations about recent transactions. But you should strongly consider taking another route and answering his question with one of your own: “In what context?”
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0A company’s value can vary by multiples, depending on the situation or perspective. A textbook valuation used for gifting may be substantially different than a valuation for a company that is considering a planned transaction. Or, if your client is focused on getting the best immediate deal, his company’s valuation probably won’t be the same as one built against a clear-eyed assessment of the business in terms of the owners’ needs for income and liquid assets.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Why do a valuation?
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0If your client is contemplating any kind of transition or transaction, or if he’s simply planning ahead, a third-party valuation can help him ascertain the value of his company in the appropriate context. A proper valuation assists attorneys as they set reasonable expectations for their clients, regardless of what’s on the horizon. And, should a client decide to move forward with a transaction, it provides a realistic estimate of the value of a business from the perspective of potential acquirers, as well as the business’s position in the current market.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Sometimes, a valuation isn’t just nice-to-have information—it’s need-to-know. Three specific situations require, or loudly call for, a valuation: tax planning, a transfer of ownership and the sale of a business. Generally speaking, the factors that determine business value are the same, whatever the reason for seeking a valuation may be. According to the IRS, eight factors should always be considered:
• The nature of the business and the history of the enterprise from its inception
• The economic outlook in general and the specific industry in particular
• The book value of the company and the financial condition of the business
• The earning capacity of the company
• The dividend-paying capacity of the company
• Whether the enterprise has goodwill or other intangible value
• Sales of the stock and size of the block to be valued
• The market price of stock of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter Value, in some sense, is subjective: what detracts from a company’s worth in the eyes of one person may actually increase the company’s worth in the eyes of another. So, while the above factors should always be taken into consideration, their importance will vary depending on the situation.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0For transfers of ownership or tax planning purposes, a valuation should simply be a logical, defensible number; here, a higher value isn’t necessarily advantageous. On the other hand, if the valuation will guide an action—i.e., the business is for sale, or will be in the near future—current market conditions will be a major determinant of value. In this case, you’ll want to focus on what’s driving the business, as well as what’s detracting from it. Based on that information, your client can find ways to modify his business so that value increases, potentially resulting in a higher purchase price if and when he hits the market.
\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Once your client has established exactly why he’s jumping into the valuation process, he’s ready to get started—almost.