How much is your business worth?
“What is my business worth?” is a common question asked by small business owners. Unlike the value of publicly-traded stock that can be readily determined, there can be many answers for a privately-held enterprise depending on the details behind the query.
For small businesses, valuations are performed for various purposes such as for compliance, specific transactions, personal financial planning, and litigation. In each of these cases, to properly find the answer to the question, the definition, or standard, of value must be designated.
For compliance purposes, business valuation engagements generally have a pre-determined set of parameters and definitions. For closely held enterprises, in the case of estate or gift tax-related valuations, the IRS issued Revenue Ruling 59-60 to clarify its position. This ruling specifies that, for IRS purposes, the “fair market value” of a business or interest is defined as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
For compliance with other IRS reporting requirements such as in the case of an asset sale transaction, the purchase agreement will typically detail how both parties are to file the specific figures with the IRS. This breakdown is an important part of the negotiation process since there could be significant tax consequences to each party as a result of this determination of assigned values.
In the case of a single transaction such as the purchase or sale of a partial or full interest in a company, the value loses the “hypothetical” aspect found in the IRS definition of fair market value. Each actual ownership transfer takes on its own value based on the motivations of the parties. A specific buyer may have synergies or may be interested in obtaining a competitive advantage that would result in a higher price. Or vice versa, a seller may be in a hardship and willing to take a lower price than may be accepted in other conditions. These nuances are sometimes referred to as investment or intrinsic value.
For personal financial planning such as in the case of a buy-sell agreement between owners or for estate planning purposes, an owner may not need formal assurance or an “opinion” of value, but rather seeks a “ball park” figure. In this case, perhaps, the owner and the business valuation analyst may follow an agreed-upon understanding of assumptions which will result in a “calculated” value.
Lastly, for litigation purposes such as divorce or shareholder disputes, the value definition may be “fair value” which is driven by case law and is ever-evolving and often determined by the courts. In other situations such as in a lost profits claim, there could be generally accepted methods to estimate the sought-after figures.
When answering the question, “how much is my business worth?” one must clearly identify the purpose of the question and ultimately determine which standard of value applies. A different result will be identified depending on the facts and circumstances. For example, the value for a minority gift in the eyes of the IRS would be different than the same minority interest in a shareholder dispute case. Or, the value for the sum of all minority interests would not likely be the same as the value of the enterprise taken as a whole.
In these cases, a certified business valuation professional can help sort through the nuances to be sure the proper result is found when determining business value.
• Michelle DellaMaria is a CPA and Certified Valuation Analyst, with Caufield & Flood Certified Public Accountants in Crystal Lake.