Article: The Many Purposes of Business Valuation


	Lynn Westergard

The many purposes of business valuation

A meaningful valuation reflects both the motivation behind it and the subjective aspects of your closely held company

The value of a business depends on many factors, including the purpose for which the value is to be applied. Some may contend that a company is worth what it is worth, regardless of the motivation behind the valuation. That contention is incorrect.

Business owners seek business valuations for any number of reasons, and each reason may carry a distinct set of influencing factors and valuation methods and standards.

Motivations. During the life of a business, many motivations may prompt the owner to determine the company’s value, including:

Minimizing estate taxes. Knowing the value of the business is essential if the owner wishes to create an effective estate plan, or if, after he dies, his survivors are to avoid a huge estate tax obligation.
Achieving a divorce-related property settlement.
Assembling a loan package. Banks commonly require valuations when stock is pledged as collateral or when loans are guaranteed by the owner of a closely held business.
Providing a reliable basis for a buy-sell agreement. Basing a buy-sell agreement on book value may seem equitable in the company’s youth. But as it matures and its value is enhanced by such non-book factors as goodwill and stability, a book value-based buy-sell arrangement can have disastrous consequences.
Establishing incentive programs. If your company’s incentive program includes awarding stock, phantom stock or stock options to key employees, all parties need to know what the stock is truly worth at various times.
Further enhancing the company’s value. Through the process of determining what his company is worth today and understanding the factors that contribute to its value, a business owner can often learn how to exploit those factors to make the company even more valuable.
Obtaining adequate insurance coverage. A reliable business valuation can help owners determine how much insurance they should carry on each other and on key employees who own stock.

Influencing factors

Once the purpose of the valuation is identified, the valuation professional will examine those factors that are relevant to that purpose. Those factors may include the following:

the nature of the business;
the competitiveness of its industry;
the business’s earning capacity;
its dividend history;
goodwill;
investor risk;
the maturity of the business;
the importance of the current owner’s direct involvement;
minority ownership and control; and
transferability of stock.

In a simple world, there would be only two ways to value a business, regardless of the purpose behind the valuation: the liquidation basis (the value of what remains after all assets are sold and all debts are paid), and the going concern basis, which also considers goodwill and the company’s ability to generate cash flow and income.

But as a small business owner, the world in which your company functions is anything but simple, especially when estimating its value. Therefore, if circumstances should ever dictate that you place an accurate value on your company, remember that it can have different values, depending on your purpose. The value you want to ascertain is the value that will help you achieve your goal.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.