It's a tricky question. It all depends upon why you're asking.
by Jill Jones
What your business is worth depends on why you are asking. Business value can and often will differ depending on the purpose for the valuation. There are various reasons as to why a business value may need to be determined. These can include estate valuation in the case of owner death, gifting of business ownership, valuation in the case of divorce, proactively establishing value for buy/sell agreement in business ventures and buying/selling businesses in the open market.
Many business owners may just ask, “Can I just look at my balance sheet to determine value?” The answer–probably not. Business value is often more than what appears on a traditional balance sheet. A business is typically worth the fair market value of its hard assets (cash, receivables, real estate and equipment) minus its liabilities. To that we add a value for goodwill (if any). Goodwill measures the intangible value of the business as a profit-making entity. It is meant to capture the value of the workforce in place, reputation of the business, customer list, etc.
Whether gifting shares, or if valuing a business for an estate that requires gift tax, or even if a business is estate tax filing with the IRS or the state, these filings typically require formal reports to be submitted with the tax forms. These reports must be in compliance with IRS regulations, or they'll face rejection. Methods used and discounting come under sharp scrutiny, and governing agencies anticipate qualified professional business appraisals.
In the case of valuing the marital assets in a divorce, the formal valuation process is similar to gifting and estate, however, family law in Indiana is very specific about how the goodwill (intangible) value of a business is to be divided in a marital estate. It notes that in the case of a professional practice, the portion of the value of business deemed to be “professional goodwill” (the value attributable to the owner/professional) is not a divisible asset in the marital estate. However “enterprise or business goodwill” (the value attributable to the practice independent of the professional) is a divisible asset along with the tangible assets of the business. This requires specific valuation approaches to separate these values for the court.
Buy/sell agreements are crucial to proactive planning. Simplistic definitions of values such as “book value” will likely not capture fair value. Selecting an appropriate valuation formula that can be easily updated will lead to less confusion when it comes time to exercise the agreement. For instance, an operating entity may be best valued at a multiple of earnings. In the case of a real estate holding company, the book value of assets adjusted for the appraisal of real estate may be more appropriate.
Whether you are selling your business or buying an existing business, computing the intrinsic value (value to the new owner) is a key component in negotiating the price. Intrinsic value is determined by modifying company financial data to remove expenses that a new owner would not incur and replace them with expenses a new owner would expect. The result is to project a cash flow stream that a potential new buyer can expect. The modified cash flow would be the basis for determining the value rather than the historical results.
Each of these scenarios can easily determine a different value for the same business. Do not confuse a value determined under one method to be valid for another. Utilize a certified valuation professional with the credentials to support the appropriate value under the appropriate circumstance. In the end, know what your business is worth.
Jill Jones, CPA, CVA, is co-owner of McMahon & Associates CPAs, P.C.
