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Should Valuations be Formal or Informal

June 28, 2011

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At some point, business owners need to determine the value of their companies for purposes such as estate planning, divorce settlement, a potential sale, recapitalization or a shareholder dispute. The article explains more about the types of valuations that can be obtained.

Business owners frequently need to determine how much their companies are worth. The valuation reports they can obtain range from informal to formal, depending on the purpose of the valuation and its intended use.

Here’s a brief rundown of the two broad categories:
1. – Informal valuations. These measures are based on wide-ranging criteria, such as multiples of net operating income (NOI) and projections of discounted cash flow. When such criteria are applied to a particular industry, an informal value can be obtained.

Let’s say a closely-held company’s NOI has averaged $120,000 for the past three years. In that particular industry, companies tend to change hands for 10 to 12 times NOI. An informal valuation, then, would put the company’s worth at $1,200,000 to $1,440,000.

Business owners may want an informal valuation before they commit to a transaction, so they can decide whether to proceed. Let’s say a business owner was thinking about selling his company. An informal valuation might indicate that the firm is worth between $1 million and $1.5 million. If the owner was hoping to sell for $2 million or more, this valuation might lead him to postpone a sale until earnings pick up and the company’s value has increased.

2. – Formal valuations. When a comprehensive formal valuation is obtained, an independent expert spends considerable time examining a company’s records. The evaluation may use several methods to determine the value of a firm.

A formal valuation is desirable if it is foreseeable that another party may present a challenge. Buy-sell agreements between family members, for example, must have formal valuations because the IRS may contend that a “sale” was partially a gift that should be taxed.

One type of formal valuation is a fairness opinion. This provides an independent objective analysis of a proposed deal from the point of view of one party to the transaction. After looking at pricing, terms and other considerations, the valuation expert makes an opinion about whether the transaction is fair or not. It is used in mergers and acquisitions, as well as other transactions.

Whenever you are concerned about possible liability, you should get a fairness opinion. Let’s say your company is making an acquisition — you might obtain a fairness opinion to show fellow shareholders that a fair price is being paid.

If you need any type of valuation, contact our firm. Whatever the reason – estate planning, business sale, the creation of a employee stock ownership plan, a divorce settlement or other purpose – we can provide you with a valuation that is supportable and will protect the interests of business owners.

Business Owners Need Valuations For Several Reasons, Including:

– Succession planning. If a business owner becomes disabled or dies prematurely, will the company’s value be maintained?
– A buy-sell agreement can ensure future security and should include a set price for the company or a mechanism for arriving at a fair one. That’s necessary for the arrangement to be acceptable to both buyer and seller.
– Estate planning. Establishing a value for a company may help a business owner anticipate future estate tax obligations, and plan accordingly.
– Moreover, a business owner may give away interests in the company to younger relatives, as part of an estate plan. A business valuation sets the value of those gifts, for tax purposes.
– Transaction planning. If an owner wants to take a company public, sell it, recapitalize it, or sell a subsidiary, a business valuation can be vital for planning.

For more information contact Brad Eberhard at [email protected].

 

copyright BizActions 2011

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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