Worcester Jewish Chronicle, February 12, 2004
Is It “Good” For You? – Business Valuation is the Key
David J. Mayotte, CPA, CVA
There will be more wealth transferred in the next 10 years than in any other time in history: The baby boomers will be retiring. With their retirement comes the disposition and transfer of their businesses.
Successful planning (along with a minimum of tax) is dependent upon the succession plans drawn up and, more importantly, having these plans put into action and followed.
According to a recent study, conducted by the MassMutual Financial Group, of the 1,143 companies that responded to the MassMutual Financial Group/Raymond Institute American Family Business Survey, more than two-thirds (67.5 percent) reported a “good” understanding of the amount of estate tax that will be due upon their deaths.
So, this sounds good, right? This does, but their expectations might be unrealistic.
Approximately 55.3 percent of the respondents to this survey indicated that they do not conduct formal business valuations of the company share value. Without this information, they cannot accurately calculate their estate tax bill. So, how can 67.5 percent of the respondents answer that they have a “good” understanding?
It appears that a “good” understanding may be “bad” news for many business owners.
So, what does this all mean? Simply put, there should be a documented succession plan that is established based on current facts and circumstances using realistic sustainable values. The succession plan should to be revised to reflect the current wants, needs and desires of the business owners as circumstances change.
How much is your business worth?
Have you ever had a formal business valuation performed? Why not?
If selling a business (known as a divestiture), a business valuator would help establish the value of the entity as a whole. The business valuator would look at similar companies in similar industries to help establish the value of the business. The business valuator would also examine the industry in which the entity operates; is the industry going through consolidation or rapid expansion? The business valuator would also examine the national, regional and local economies as it relates to the entity being valued. Today, more than ever, companies are dealing with customers all over the world.
If gifting a business (to family members, for instance), a business valuation may be needed and attached to the gift tax return. Documentation, such as a business valuation, needs to be included with the gift tax return if minority interest and/or lack of marketability discounts are taken against the value of the interest gifted. Of course, without proper documentation, the IRS could successfully argue that the statue of limitations (generally three years for gift tax returns) never started because adequate documentation was not given. Do not let that happen to you.
A minority interest is usually defined as an interest that is less than 50 percent. Lack of marketability tries to compensate for the illiquidity of the entity’s common and preferred stock. The vast majority of all businesses out there are closely held, non-publicly traded. The stock of these entities cannot be exchanged or sold on a timely or efficient manner.
Maybe, instead of selling a business, one is buying a business (known as an acquisition). Wouldn’t it be nice to see what an independent third party thinks of the company that you are buying? And, more importantly, the price that you are paying? A business valuator would examine the company’s strengths and weaknesses and determine the fair market value of the company.
This leads to a very important phrase: “fair market value.”
The IRS and the courts have defined this as follows:
“The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
Even when succession plans come together, circumstances beyond your control may go awry. The best succession plans and implementation could be affected unexpectedly by litigation.
Many times, business valuations are required for litigation support such as shareholder disputes and divorce. State law governs disputed property settlements. In fact, most states have yet to establish standards of value. Fair market value is usually not used in such cases.
Instead, fair value is usually the required premise of value. The definition of fair value is as follows:
“The value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.”
This is a far cry from fair market value and can be more subjective.
In divorce proceedings, the business valuation is performed under the guidelines of the state in which the couple is getting divorced. In most states, discounts for minority interests and lack of marketability are not allowed. The court usually determines the date of the business valuation.
As one can see, business valuations are important to today’s business owners as a key part of their succession plans. Business owners should seriously consider if they should obtain an independent opinion of value on their business.
Most importantly, succession plans should reflect the current wants, needs and desires of the business owners.
David J. Mayotte, CPA, CVA is a manager with Greenberg, Rosenblatt, Kull & Bitsoli, P.C., located at 306 Main St., and specializes in business valuations and closely held businesses. He can be reached at 508-791-0901.