Many times we at Synergetic Finance receive requests to do business valuations, and it is important to go over a pre-engagement checklist with the prospective client before it makes sense to continue the work. This is to protect everyone involved and to help us do a good job and keep our clients happy. Some questions initially come to mind: Is this a business with serious issues, making it difficult to value? Does the business have a realistic time frame to do the job properly? Are we able to be objective and independent in analyzing the value of this business? And, most importantly, why is the business requesting a valuation?
This last point is critically important as the purpose of a business valuation determines the course of the entire engagement. The purpose influences our conclusion of value, which is the key number from which so many decisions are made. In giving professional advice about value, we are looking to generate a simple calculation: the economic value of an entity is equal to the economic benefit (usually cash flow) generated by the business divided by the risk (return) to achieve these benefits. Complexity occurs when calculating each component of this equation as there are many smaller calculations to be performed. A competent valuator with the same training may arrive at different conclusions by looking at the same data. The purpose of valuation drives decisions that are made along the way in determining which elements have greater weight.
Here are a few common purposes for performing valuations. Knowing the difference will help a business better understand why the results of business valuations might differ.
1. Estate & Gift Tax: Performing valuations for tax purposes involves calculating the fair market value as defined by the IRS. In collecting taxes, this number takes into account a hypothetical willing buyer or seller (not necessarily an actual one) should a transaction take place.
2. Divorce: Determining the value of a business that is involved in dissolving a marital partnership has different criteria. Business assets are split up considering that operations will not continue. Value is estimated through what the business is worth at the present moment considering that the marriage and business operations may not continue into the future.
3. Shareholder Dispute or Buyout: Buying out other owners or restructuring a company with changes to equity holdings assumes that a business will continue. The company’s value may also vary based on a discount for lack of marketability and a discount for lack of control.
4. For a buy or sell agreement (mergers & acquisitions): Valuation is a starting point for buying and selling transactions established during the negotiation process. Value, by this definition is not an independent assessment, unlike those listed above. Different buyers have different needs and look at value from the perspective of what they want to do with the business. One investor may look at a company as a bargain whereas another may look at it as overpriced. It depends largely on the buyer’s plans to change things going forward. And sellers often have needs that go beyond price.
These are just a few different purposes for doing a valuation. Do you know why you are getting a valuation performed on your company or are you doing it because it sounds like a good idea? Knowing this can make a big difference in what the final conclusion of value might be. Adding a valuation to your strategic plan that fits in with your overall goals and objectives makes the most sense. We believe that the best time to plan your exit is before you start (i.e., exit planning). Please contact Synergetic Finance to discuss your plans.
To your success,
Mark Girouard, MBA