A business valuation is necessary because ownership interests in privately held companies often represent a significant portion of one’s estate and/or portfolio. The value, or worth, of an interest in a privately held company, as opposed to stock in a public company, is usually unknown because there is no active market to sell or trade that interest from which to ascertain or approximate value.
Value determinations are most commonly needed to calculate estate tax upon death, split up family assets in a divorce, and negotiate value in a purchase, sale, or merger of a business enterprise. Other common reasons why a holder of an interest in a privately held company might require a business valuation include:
- Adequacy of Life Insurance
- Buy/Sell Agreements
- Bankruptcy and Foreclosures
- Charitable Contributions
- Disruption of a Business
- Dissenting Shareholder Actions
- Eminent Domain
- Employee Stock Ownership Plans (ESOPs)
- Franchise Valuation or Evaluation
- Gifting Programs
- Gift Taxes
- Incentive Stock Option Programs
- Initial Public Offerings (IPOs)
- Liquidation or Reorganization
- Obtaining Financing
- Partner Disputes
- Succession Planning
One of the best reasons for obtaining a business valuation is to use it as a management tool. A prime objective for all business enterprises is to improve and maximize its value to the owners. A properly prepared business valuation provides management with insightful information that helps identify company strengths and weaknesses that affect value, allowing them to more effectively focus their energies in places that really count.
A periodic business valuation also serves as a measurement tool to help owners assess overall success and management effectiveness. The National Association of Certified Valuation Analysts, the nation’s leading organization supporting the business valuation discipline, recommends a valuation of a business enterprise be performed every two years for management purposes, if for no other reason.
Many business owners believe the value of their business is net profit, or gross sales, multiplied by some industry rule of thumb. It’s not. In fact, using an industry rule of thumb formula often results in a value determination that differs greatly from the actual value that could be determined by a qualified business valuation professional.
The true value of a business is based on two kinds of assets: Tangible and Intangible.
- Real estate
- Customer lists
- Trademarks and/or copyrights
- Distribution rights
- A superior management team
- Non-compete agreements
- Physical location
- Special processes
- Name recognition
Quite often, the value of a company’s intangible assets is much greater than the tangible assets. Valuing intangibles, however, is where one needs the services of a qualified business valuation professional: it requires a careful analysis of many aspects of a business enterprise and requires skills acquired through specialized training and experience.