Smart Business Detroit

Determining value

Why a business valuation is important for every company By Erin Hollis

Why is a succession plan important for a business owner?

The average business owner spends approximately 10 hours per day, six days per week to get the business to the point where it can provide a measure of security and comfort for the owner’s family. At some point, control of the business will be transferred, often to a family member.

Succession planning is necessary to ensure the successful transfer of the owner’s interest and should not be written and applied without a business valuation assessment to know the owner’s total business worth. Regular valuations of the business, in combination with professional taxplanning strategies, allow transfers to occur with minimal tax consequences.

In incremental amounts, a business valuation allows transfers to occur with zero tax implications.

How can a business valuation assist in reducing or eliminating estate and gift taxes?

In 2006, estate taxes can be as high as 46 percent. Engaging an experienced, accredited valuator provides a level of inoculation for heirs, as the interest owned by a deceased business owner is one of the most heavily litigated and intensely disputed issues of estate tax determination.

If the value reported is unsubstantiated, or the IRS disputes the value derived, the IRS will assign a recalculated value. Furthermore, the IRS may also assess undervaluation penalties that can range from 20 percent to 40 percent, meaning heirs must deal with the tax nightmare of an undervalued estate.

Valuation discounts can be utilized to reduce the value of transferred ownership, thereby decreasing estate and gift tax impositions.

It is permissible to gift up to $12,000 (in 2006) to as many people as desired, free of any gift tax. There are more than 20 valuation discounts, and when gifting stock with valuation discounts, exempt gifts can be increased by 50 percent or more.

Why is it important to have a business valued when constructing a buy-sell agreement?

Only an estimated 30 percent of businesses have a continuity plan, and onethird of them are not in writing. Many are outdated. The buy-sell agreement is the crux of a business’s continuation plan and the owner’s estate. It controls who can or must buy a departing owner’s shares, as well as the events that will trigger a buyout.

The valuation establishes the amount needed to fund the agreement and the price that will be paid upon an owner’s timely or unplanned exit. A properly structured buy-sell agreement, in combination with an accredited valuation, assures a smooth transition of ownership.

Can proceeds from the sale of a business be used to fund a retirement?

Approximately 75 percent of owners invest their own net worth in the business, and many never see the materialization of the full investment again. As one of the largest assets in the owner’s estate, the business should be valued regularly to gauge the owner’s return on investment and assess the company’s market value.

If an owner desires to sell to a third party and utilize the sale proceeds to fund his or her retirement, then regular valuations are essential. The value determined allows a business owner to gauge if he or she is on track toward meeting retirement goals in the desired timeframe.

An owner who is contemplating a sale should keep in mind that competition in the closely-held marketplace is steep, and the pool of potential investors is much smaller than that available to publicly traded companies. Planning the exit is key if an owner ever hopes to receive a desirable sale price to fund retirement goals.

How often should a business valuation be updated?

A professional business valuation is valid for as long as its core assumptions remain valid. Absent any substantial changes in business structure, ownership or ownership intent, and depending on the nature of the business and change in profits, an update should be conducted approximately every two years.

In the event there is a change or substantial and sustained increase in profits, the valuation should be updated immediately subsequent to that event. However, long-term, annual updating is necessary, such as when families sell or transfer minority business interests each year as part of their estate and succession planning.

ERIN HOLLIS, AVA, is the business valuation manager for Accountancy Associates LLC, a related company of International Profit Associates. Reach her at www.ipa-iba.com or (800) 531-7100.