From time to time, every small business owner wonders what the value of their business is. The correct answer can vary, depending on the purpose of the appraisal. Different rules and standards of value may apply in different circumstances.
Some of the reasons a business owner may want a valuation include: General business planning, planning for the potential sale or purchase of a business, tax purposes, business litigation, including shareholder disputes, marital dissolutions, and financial reporting.
Here’s a closer look at some of these:
The first time a valuation need arises is often for general business planning purposes. A business owner could be wondering about what their investment is worth in the marketplace, and ways to increase that value. Or maybe they’re looking at capital investment options and want to make sure to make a wise decision.
Unfortunately, many business owners rely on do-it-yourself appraisals for internal decision-making purposes. Often these in-house estimates are based on industry rules of thumbs, and can be outdated or ambiguous.
A credentialed business valuation professional can help build forecasting models that business owners can use to show how changes in various assumptions affect value. They can also estimate the company’s cost of capital, which is used to perform discounted cash flow analyses.
When valuing a business for internal purposes, a business owner may be interested in how the company would be perceived by hypothetical buyers. Fair market value might be relevant in this scenario. But if the business owner is interested in what it’s worth to a specific buyer, investment value is more relevant. Often strategic buyers are willing to pay a premium above fair market value due to synergies.
Estate, Gifting and Tax Purposes
Estate planning allows families to transition ownership of closely held business interests to the next generation. Proactive planning can dramatically reduce the amount of estate taxes heirs will someday owe.
Closely related, of course, is the need for a business valuation when a shareholder dies. Tax authorities rely on a qualified appraisal by a qualified appraiser to determine the value of the business. In turn, this value is used to help determine the estate or death taxes for both IRS and state purposes. A credentialed business valuation professional is able to prepare a qualified appraisal for gift and estate tax purposes. Here, fair market value is always the appropriate standard of value.
Financial Reporting Purposes
Sometimes businesses are required by U.S. Generally Accepted Accounting Principles (GAAP) to record assets at fair value. For example, if one company acquires another company, it’s necessary to allocate the purchase price of the target company to its assets and liabilities. This requires the valuation of identifiable intangible assets that weren’t on the target company’s balance sheet, such as brands, patents, customer lists and goodwill. Often these valuations are outside the comfort zone of in-house accounting personnel, so it pays to hire an outside expert who will get it right.
Different Answers to Similar Questions
The value of a business varies depending on the purpose of the appraisal. This might seem counterintuitive, but value is case-specific and different rules apply in each scenario. These differences explain why clients can’t simply reuse old appraisals for new purposes. Different standards of value may apply, or market conditions may change over time. For this reason, when trying to figure out the value of your business, always discuss the intended uses of an appraisal report with Filler & Associates.