The Ohio Manufacturer & Contractor,

What Is Your Business Worth?

By Erin Hollis

Although manufacturing operations tend to have substantial capital assets, there is far more to the value of the business than is apparent in the numbers on the balance sheet.

As an owner, your business is one of the most important investments you’ll make in your life. Over time, the business grows and so does your initial investment. How much is your initial investment worth today? You’d probably say it is worth more, but how much more? Although manufacturing operations tend to have substantial capital assets, there is far more to the value of the business than is apparent in the numbers on the balance sheet. Business value also includes the sweat equity, the time and devotion an owner contributes. This is commonly referred to as "goodwill", an intangible asset that substantially increases a company’s worth and attractiveness to an outside buyer. In a nutshell – an owner of a manufacturing operation must look beyond the tangible assets to know the value of the company.

What is a Business Valuation?
The share value of publicly-traded companies is easily accessed by looking in the business section of the daily newspaper, locating the stock tables and multiplying the closing price by the number of shares owned. However, there is no convenient stock value table to access for privately- held companies; that value can only be accurately determined through a professional business valuation. Do I have adequate life insurance for my business needs? Knowing the worth of a business is a prerequisite for assessing the required amount of life insurance to fund buy-sell agreements.

What’s the return on my investment (ROI)? Establishing a benchmark value to compare to the owner’s original investment provides a reasonable estimate of ROI.

What is my company’s intangible value? For job shops, intangible value includes customer loyalty, generating new business, competitive pricing, and retaining skilled journeymen.

Will I be able to finance? A valuation assists lenders in the process of qualifying applicants.

Will proceeds from the sale of the business fund my retirement? Knowing the value of the business enables ease of retirement planning.

How much is my estate worth? An accurate determination of value enables an owner to implement estate tax minimization strategies.

Uncommon Sense
It doesn’t make sense that business owners regularly track their personal stock investments and real estate values yet rarely give any thought to the worth of their most valuable asset – their business. This is surprising considering that a professional valuation brings to light areas of mediocre or ineffective financial performance that when addressed, often result in greater future value. Instead, some business owners use outdated or inaccurate methods to determine value. The most common mistakes are:

• Using an industry formula to determine value.
• Thinking the sale of a competitor’s business is a good indicator of value.
• Failure to consider the tax implications of improper estimates.

Why Plan For Exit Now?
The further one plans ahead, the more time available to enhance the value of the business. A valuation serves as a benchmark for designing an exit strategy. It determines the fair and equitable price for a partner buyout and the baseline for an estate plan that protects an owner’s family. In the event of an untimely exit, an owner who has plans in place can minimize financial burdens on the estate and decrease the family’s distress.

The tax consequences associated with improper planning can be devastating. Estate taxes may be as high as 47 percent of the gross estate (in 2005), and the IRS can assist under-valuation penalties of up to 40 percent of the difference between the taxpayer’s assessment and its own assessment. The IRS audits all estate tax returns, and if a valuation hasn’t been conducted for several years, it’s likely the business will be undervalued at the time the return is filed.

Valuation Discounts Provide Significant Advantages.
A professionally prepared valuation includes the application of IRS-sanctioned discounts. There are in excess of 20 different valuation discounts, including:

Lack of marketability discount. This applies to closely held businesses, for which there is virtually no market for shareholder interests.

Minority interest discount. This discount implies a noncontrolling interest for owners with less than 50 percent of the total voting stock.

Key-person discount. A company’s success may be dependent on a single key person, and thus the loss of such a person would result in adverse consequences.

Experience Is Essential. Every industry is unique. Some may be more complicated than others to value, and therefore, it is essential to engage only an experienced industry valuation professional who will know key manufacturing industry valuation issues, such as:

Machinery. How often is machinery purchased or updated? Is the company able to purchase new equipment regularly? Does the machinery require highly experienced technicians?

Certifications & Education. Is the company ISO certified? Are employees regularly educated on new techniques?

Litigation. Do litigious claims or events, such as workman’s compensation or environmental issues exist?

Employees. What is the required skill level? Is the company union-affiliated? How are experienced journeymen retained? What benefits are offered, and can the company afford to maintain those benefits?

Pricing. How has the rise in material costs affected the company?

Competition. How are new clients gained and existing clients retained? Without proper experience, someone other than an industry specialist might not apply the correct valuation method, resulting in an inaccurate assessment of worth. Furthermore, a valuator unfamiliar with the types of intangible assets specific to the manufacturing industry may focus too heavily on profit and miss the important contribution intangibles bring to the company.

A Good Rule of Thumb
Update the business valuation every two years to ensure a current, accurate assessment of ownership value. Or, if the business grows substantially over one year or experiences a significant event, re-assess more often.

In the manufacturing sector, savvy business owners know their business’ worth to maximize their return on investment and protect their estate plan from the consequences of untimely life events.

About the author:
Erin Hollis, AVA, is the valuation manager for AAL, a related company of IPA. IPA and its combined family of consulting firms provide comprehensive business consulting, tax planning and business valuation services to companies in the United States and Canada. For further information, call (800) 531-7100 or visit www.ipa-iba.com