Business Valuation: Why businesses are appraised
Business valuations are performed for a variety of reasons. Some of the more common reasons include:
• Mergers and acquisitions
• Purchase price allocation
• Estate and gift taxes
• Marital dissolution (divorce)
• Employee Stock Ownership Plans (ESOP)
• Liquidation or reorganization
• Buy-Sell Agreements
• Stockholder disputes
• Financing
• Stock option incentives
• Initial Public Offering
• Damages litigation
• Insurance claims
• Charitable contributions
• Eminent domain actions
• Financial reporting
The above list does not contain all reasons for having a business valuation but helps us to shape the more common areas. We would like to discuss a few of these areas in more detail.
Mergers and acquisitions: This is the area of traditional business buying and selling some or all of a business interest. These services are often done for the seller prior to listing the business for sale, or for the buyer as a part of due diligence in brokering a purchase. In the case of a merger, both companies will generally be valued as a part of the process of joining into one new company.
Purchase price allocation: Internal Revenue Code Section 1060 requires that, when a business is acquired, a valuation must be performed to support the allocation of the total purchase price to the component parts for income tax purposes. This became especially important after the Tax Reform Act of 1986 which requires a uniform allocation of the purchase price based on an appraisal to be reported by both the buyer and seller on their tax returns in the year of sale.
Estate and gift taxes: The valuation of closely held businesses is an important estate planning consideration. In 2017, when the Tax Cuts and Jobs Act was passed, the estate tax exemption was increased to over $11 million per individual and was set to index for inflation going forward. While this eliminated estate taxes for many individuals, it is still a concern for wealthier individuals with a greater amount of assets to consider. Charitable contributions can also fall under these types of valuations. Generally, this is done as a component of advanced estate planning.
Marital dissolution: In a divorce, most couple’s assets and liabilities are valued regardless of if the state follows equitable distribution or community property rules. It is common to have a non-publicly traded business interest valued whether the ownership interest is 100% or a minority interest. Usually, the business itself is not divided between spouses. Rather, one spouse would keep the business and the other receives different assets of equal value as a distribution.
Buy-Sell Agreements: A buy-sell agreement allows parties in a closely held business to acquire the interest of another owner who is withdrawing from the business. There are many reasons an owner may withdraw: legal action, divorce, death, and/or retirement. The agreement may contain a designated amount, formula, or most recent valuation to determine the price that the remaining owners of the entity will pay to acquire the interest. Often times the payment terms and conditions may vary by the reason for the transaction.
Stockholder (Owner) dispute: Owners generally go into business together with the best of intentions. Sometimes events occur that cause the owners to need to “breakup” the company. Many states allow corporations to merge, dissolve, or restructure without unanimous consent. Many of these cases come from dissenting shareholders filing lawsuits to allow their shares to be valued as if the event had never taken place.
Damages litigation: Many court cases involve damages. For example: compensation for patent infringement, illegal price fixing, breach of contract, lost profits, and/or lost business opportunities to name a few. Others can be for items such as discrimination or wrongful death. These cases often require a valuator to value the business twice. The first is what the business is currently worth. The second is what the business might have been worth had the action not occurred. Insurance claims also fall under these types of valuations.
Why is the purpose important?
The purpose of the valuation impacts the valuators process. A valuation in divorce for example can vary by state, county, and locality depending upon prior case law in effect. Valuing a minority interest may mean fewer adjustments can be considered. Is there a need to separate personal goodwill from enterprise goodwill? All of these things and many more need to be considered before proceeding with a business valuation and working with a knowledgeable expert can help in the process.
Working with an experienced business valuation expert.
As discussed above, we listed just some of the reasons business valuations are performed. Working with an experienced business valuation professional can help you determine the circumstance, need, and type of valuation that should be performed. A valuation professional can bring clarity to the process and assurance that the services you are being provided result in a value to you.
I’m Gregory M. Clark, MSA, CPA, CVA, MAFF of GMC & Company. I help attorney’s and their clients in litigation matters with business valuation, litigation support, forensic accounting, and consulting. If you have a shareholder dispute, or are going through a divorce and need a business valuation or forensic services, let’s talk! Call us at 219-554-9700 or email us at info@gmcandco.com.
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