A business valuation is a process taken to establish a value for an entire or partial interest in a closely held business or professional practice , taking into account both quantitative and qualitative tangible and intangible factors associated with the specific business being valued.
Definition : The act or process of determining the value of a business, business ownership interest, security, or intangible asset (as defined in the International Glossary of Business Valuation Terms).
Business Valuations need to be performed by qualified and experienced valuation firm under the following conditions:
a)The firm represents itself to the public as an appraiser or performs appraisals on a regular basis
b)The appraiser is qualified to value the type of property
c)The appraiser is not a related party.
Some Of The Common Purpose Of Business Valuations Are Expanded In The Following Paragraphs.
Whenever a company merges with another company, is acquired by another company, or sold, a valuation is necessary. In a merger situation, a professional may be asked to establish an “exchange value” of the companies involved. The valuator may be engaged to establish the value for either or both of the companies. Ina sale or divestiture of a company or of an interest in a company, the seller may engage a professional’s services to establish a range of values of the business that will assist the seller in negotiating a sales price. Conversely, a person or company may engage a professional to perform a valuation of a company they want to acquire. When businesses are acquired, they are often acquired for a flat or lump-sum amount. For accounting and tax reasons, the lump-sum purchase price must be allocated among the various classes of tangible and intangible assets of the business.
Business Valuations For Legal Support
For a variety of reasons, an attorney involved in a pending lawsuit might need to determine the value of a closely held business. The professional, as the expert, will be asked to give expert testimony regarding the conclusions. The need for litigation support4 relative to business valuations can arise in divorces, partner disputes, dissenting shareholder actions, insurance claims or wrongful death and injury cases.
Business Valuations For Regulatory Matters – FAS 141 and 142
The FASB now requires that independent business valuations be made to establish the purchase value of all intangibles included in a business combination. Similarly, FAS 142 requires an annual review of the values of intangible assets in order to measure whether or not any impairment of the original or carrying value has occurred. Under Sarbanes-Oxley, an independent auditor is explicitly forbidden to provide “appraisal or valuation services, fairness opinions, or contribution-in-kind reports” for any of its audit clients.
Business Valuations For Buy- Sell Agreements
All closely held businesses should adopt a buy-sell agreement among the partners or shareholders. Much protracted litigation could be avoided if, in the beginning, the business owners would address the issue of a buy-sell agreement in their partnership or shareholders agreements. A buy-sell agreement is an agreement that establishes the methodology to be followed by the parties regarding the ultimate disposition of a departing or a deceased owner’s interest in a closely held business. The process of determining the value of the business is directed by the buy-sell agreement and there are many alternative procedures for doing so. Some buy-sell agreements provide for the determination of value merely by agreeing to a value at the beginning of each year. Some agreements are based on a predetermined or prescribed formula, whereas other agreements require that an independent business valuation be performed periodically. Regardless of the alternative selected by the owners, a professional may be asked to assist in the business valuation process.
There are two basic types of buy-sell agreements: the stock-repurchase and cross-purchase agreements. Under a stock-repurchase agreement, the company agrees to purchase the interest of a departing owner. A cross-purchase agreement allows the remaining owners to purchase the departing owner’s stock.
An appropriately constructed buy-sell agreement will address several important items, including:
What events (e.g. death, disability, etc.) trigger the buyout?
How will the buyout be funded: insurance, financing, or something else?
How soon will the buyout occur, in 30 days, 60 days, or longer?
How is the interest to be valued, i.e., based on a fixed value, formula, or a valuation?
When preparing a business valuation report, one should always review the existing buy-sell agreements for restrictions, valuation methodology, terms of purchases, etc.
Business Valuations For Estate, Gift and Income Taxes
In many cases, the value of an interest in a closely held business is an individual’s primary asset. The value of the closely held business must be ascertained to adequately perform a thorough and comprehensive estate or financial plan. It may also be necessary to establish the value of an interest in a closely held business to properly prepare estate or gift tax returns and to establish the basis of inherited stock in the hands of an heir to an estate.
Age demographics, as previously stated, will involve parents wanting to retire who will have to properly deal with the value that has accumulated in their closely held businesses. There are various ways a business owner can transfer the value that has accumulated in a closely held business. These include giving •the business to the heirs, selling the business to the heirs or to third parties, or giving the business to a charity. Regardless of how the business is transferred, an independent business valuation of the business interest is imperative.
If parents die before making transfer arrangements for the business, a value will have to be established for reporting on an estate tax return.
The universal standard of value for gift, estate, and inheritance taxes is “fair market value.” Fair Market Value is defined in Revenue Ruling 59-60 as.”the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
Revenue Ruling 59-60 also outlines a number of valuation methods and techniques which have become generally accepted and which must be considered in each case. However, as previously mentioned, valuation is as much an art as a science. The final determination of value under the regulatory standard will depend upon the facts and circumstances of the particular valuation.
Business Valuations for Employee Stock Ownership Plans (ESOPS)
An ESOP is a type of employee benefit plan. It is considered a defined contribution plan and is intended to invest primarily in the employer’s stock. The ESOP is a mechanism by which employees become beneficial owners of stock in their company. Generally, any non-publicly traded company with an ESOP must obtain a valuation of its stock on an annual basis. One significant advantage of an ESOP is that shareholders of a closely-held corporation can defer taxation on the gain resulting from their sale of company stock to an ESOP, provided the ESOP owns 30% or more of a company’s shares after the sale. In order to defer the gain, the seller must reinvest sale proceeds in qualified replacement property (QRP) consisting of stock or bonds in operating companies in the US.