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When Do You Need a Business Valuation?

When Do You Need a Business Valuation?

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A business valuation is often required to accomplish various personal, estate or business goals. There are certain life events that require business owners to get a business valuation.

First though, you might ask, “Why am I getting a business valuation as compared to simply estimating it based on some industry rule of thumb?”

Reasons to Get a Formal Valuation Rather than an “Estimate”

  • You want the parties you are dealing with to know that the right numbers matter to you. This enhances your credibility in any business dealing with third parties.

  • You want to make a good decision on the strategy you are considering. In order to ensure the strategy makes sense, you need to know the numbers you are using are correct.

  • You want to protect your family or give direction to your advisors in case you are not there to help evaluate the company when making decisions. This means getting the proper valuation of the business that you, as the owner, have time to provide input on. If you have a valuation prepared that you believe in, your planning will be much more clear and decisive.

  • To try and put a valuation in perspective, consider home values. The value of your home is assessed regularly and you know what your neighbors sell their identical house for, so you have a good idea of the value of your home, which helps you make many personal credit, investment and spending decisions. You get valuations of your jewelry and in most cases these assets pale in comparison to the importance of a business in your life. Knowing what your business is worth and understanding the factors that go into that valuation gives you a strong position to go forward with whatever planning is required.

When Do You Need a Business Valuation?

There are a number of life events that should push you to get a business valuation so that you can make smart decisions about the choices and decisions in front of you.  

Let’s explore six key life events that make a business valuation a necessity.

1.  Estate Planning

People do estate planning for two primary reasons. One, to ensure that assets will pass efficiently and as desired to their beneficiaries and second, to reduce or avoid unnecessary estate taxes and expenses.

In order to make good decisions during the estate planning process, you must know how much your estate is worth. The question becomes, how can you know what your estate is worth if you do not have a valuation of your business?

The valuation becomes even more important as you begin to explore planning alternatives such as discounted gift strategies. These types of strategies require a valuation to determine the amounts to transfer. In addition, in order to ensure the benefits of a discounted gift, a valuation must accompany the tax return sent to the IRS.

2.  Sale of the Business

If you are considering selling your business to a third party, or acquiring another company, a valuation that’s prepared before negotiation begin will put you in a position of power. Knowledge is power, after all.  

When you have a good idea of the value of a business, you can avoid wasting time looking at deals that do not make financial sense. A properly prepared valuation can help bridge the gap between different opinions of value, as the parties involved in negotiations can examine the key variables used in the analysis. This can help the parties strike a deal.

3.  Development of a Buy-Sell Agreement Between Owners

Having a buy-sell agreement in place between multiple owners ensures a smooth transition of a business in events such as death or disputes among the owners. The owners of a business often fund these agreements with an insurance purchase. You need to know the value of the business to determine the amount of insurance to buy.

4.  Succession Planning

Another business transfer event is succession planning, whether you plan to sell the business to key employees, or create a gifting strategy to move assets to other family members. In either event, you need to have a business valuation to structure an achievable plan.

5.  Litigation

Litigation is another event that triggers the need for a valuation. If a minority owner sues because of oppression by the controlling shareholder or defending a case related to economic damages related to for example a patent infringement or personal injury suit, the value of the business can become a key factor in being able reach a settlement.

6.  Divorce

When facing a divorce, the business is often one of the most valuable assets in an estate. Not surprisingly, the parties usually end up having vastly different opinions when it comes to the value of the business.  

The value of the business becomes a key factor in negotiating a settlement. The earlier you get a valuation completed and then begin figuring out how that value will be divided, you can move toward a reasonable settlement of the divorce.  

My experience has shown that nothing hurts the value of a business more than a divorce. This drop in value occurs not because of the division of family property, but because the process of going through a divorce usually causes the operating spouse to lose focus on the success of the business. As you can imagine, this results in a lower value at the time a divorce case is getting ready to settle, and this only exacerbates the difficulties in reaching a reasonable settlement.  

Other Events Requiring a Valuation  

  • If the company is considering establishing an ESOP (Employee Stock Ownership Plan), a feasibility study is needed and a key part of that study is the valuation of the business to determine the practical issues of establishing an ESOP.

  • Many times, lenders require a valuation of a business to help determine whether financing will be granted to the company.

  • When you convert from a “C” Corporation to an “S” Corporation, a liability potentially exists for a tax on the built-in gain, which is measured at the time of the conversion. A prudent business practice is to prepare the valuation to determine what this built-in gain is, as this is reportable on the tax return for the company and this potential tax may enter into future plans the company makes. It is certainly easier to value the business today, as compared to five or seven years down the road, when an event might trigger the built-in gain.

  • One final item that is not normally discussed is that a valuation can help identify strengths and weaknesses in the operations of a company. For example, it can show how a company is or is not performing as expected for the industry. This provides the owner the information he/she needs to make changes, and to enhance the value of the business.

Need Help?  

To learn how much your business is worth, contact us online or call 800.899.4623.

how much is my business worth

This post was originally published in June 2014 and has been updated for accuracy and comprehensiveness.

Published on April 23, 2021