Closely held family businesses represent a significant portion of all business enterprises operating in the United States today. These businesses do not have the marketability benefit of publicly traded competitors like IBM or Ford, nor are their stock prices determined in the public markets through exchange trading. Therefore, putting a price tag on a closely held family business requires that a business valuation be performed.
The business valuation process considers not only the current financial condition of the subject business, but examines that Company’s unique competitive advantages. These advantages can include the Company’s superior growth prospects or profitability, its market niche, or its ability to mitigate risk through diversification or through patent protection. A business valuation looks at all the factors that affect the subject business including the industrial, competitive and economic environment in which the Company operates.
Typically, valuation analyses are prepared when the owners are contemplating a sale or the business owner dies. However, there are unlimited reasons why these analyses are performed and compelling reasons why one should be performed. Need based valuations might include the following scenarios:
- Establish the fair market value of gifts, charitable contributions, decedent’s estate valuation and price for a related party transaction.
- The owner may be going through a legal proceeding that would require a valuation, as in the case of divorce, partnership termination (business dissolution) or litigating damages.
- The owner may have received an unsolicited offer to buy the business and would require a valuation to determine the reasonableness of the offer.
- In the case of an acquisition, an appraisal would be needed to allocate the purchase price for accounting and/or tax purposes.
- Two business owners might want to form a joint venture. Therefore, a valuation would be needed to determine the respective contribution percentages.
- To establish buy/sell formulas in stock purchase or partnership/LLC agreements.
- To set the value for officers/owners life insurance policies.
- To set the fair market value price for an Employee Stock Ownership Plan (ESOP) transaction.
However, the most compelling need for a business valuation is to help the owner develop a long-ranged strategic plan. Often times, family businesses lack the infrastructure of a formal accounting/corporate finance function, and therefore need the help of an independent valuation consultant to help develop and document a long range strategic plan for the company. Even if the initial forecast changes, setting up the forecast enables the owner to quantify his/her Company’s success by establishing growth and performance benchmarks in light of risk, industry, economic and competitive factors. The valuation process provides a disciplined approach to evaluating these factors and by its nature, formalizes a long range plan.
Critical to this process, is engaging an accredited valuation specialist that practices exclusively in the valuation area. Organizations such as the American Society of Appraisers’ (Accredited Senior Appraisers (ASA) designation) or the AICPA (Accredited Business Valuator (ABV) designation) are widely recognized accrediting organizations whose members must meet rigorous academic and experience requirements in order to qualify for valuation certification. Further, these appraisers are required to meet minimum certified continuing education requirements. Advanced degrees and/or certifications such as a CPA or Masters of Business Administration (MBA) give the appraiser a broad body of knowledge from which to draw upon and should be a consideration when picking a qualified expert.
A valuation utilizes a three-pronged approach to ascertain the value of a business enterprise. The three methodologies are the income approach, the market approach and the cost or adjusted book value approach. Depending on the scenario, one or more of these approaches will not apply. A good example of this is exhibited in a minority interest shareholder scenario. This type of shareholder does not have the ability to sell the underlying assets of a business due to his/her lack of control. Therefore, the cost or adjusted book value method would not be an appropriate methodology to apply.
In the income approach, a company’s future earnings capacity is determined with reference to its past history, expected growth rates and risk. To arrive at the value of the subject business, cash flow streams are projected and then discounted back to its present value equivalent as in the case of variable growth scenario, or capitalized if it is determined that a single period forecast represents a suitable proxy for normal stabilized growth for the company. It should be noted that companies with strong, sustainable cash flows and that have unique competitive advantages such as patents are generally more valuable than businesses without these attributes.
The market approach is a general way of determining a value indication of a business or equity interest using one or more methods that compare the subject to similar investments that have been sold. It has its theoretical basis in the Principle of Substitution, which states that the value of something tends to be determined by the cost of acquiring an equally desirable substitute. Market transactions in businesses, business ownership interests or securities can provide objective, empirical data for developing value measures to apply in business valuation. Such value measures are frequently derived from “guideline companies.” Guideline companies are companies that provide a reasonable basis for comparison to the relative investment characteristics of the company being valued. These comparisons include markets, products, growth, and cyclical variability. Multiples of revenues, and pretax income and book value are generally applied to the subject company’s earnings or book value. A second market method looks at transaction multiples of comparable companies sold. It is important to note that deal terms, ownership interests in terms of control or minority shareholders and/or synergies impact these multiples. Therefore, the appraiser needs to evaluate these transactions and make necessary adjustments before they are applied to the subject company’s income, cash flow or equity in order to arrive at a reasonable value conclusion.
The asset or adjusted book value method in simple terms takes marks to market the value of the Company’s assets. The Company’s liabilities are deducted to arrive at the value of the Company’s equity. It is most appropriate to use in asset intensive businesses and or as a basis for liquidation.
For tax related valuations, the premise of value is fair market value. It is defined as “the price at which the property would change hands between a willing buyer and willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of the relevant facts” . Therefore, depending on the interest being sold or transferred, discounts for lack of control and marketability are considered. In the case where a company is being sold, the premise of value may be investment value or strategic value depending on who the acquirer is. Under generally accepted accounting principles (GAAP) the value definition is fair value. It is important that the standard of value be determined on the onset of any valuation engagement.
A business valuation is a complex analysis that results in a value opinion based on a qualified appraisers judgment, experience and training. It is an art rather than a science. It is also a collaborative process between the appraiser and his client. The valuation process may provide the business owner with an objective look at his/her business in light of competitive, industrial and economic factors. This competitive intelligence may confirm the owners’ already comprehensive understanding of the factors that impact his/her business in terms of pricing, consolidation, technology trends and competition. Further, it may provide the owner with new ideas to enhance his/her business that can translate into additional value over the long haul. Therefore, the benefit of performing a business valuation is that it sets a value benchmark and provides the owner with a mechanism to compare actual results to forecasted results. This comparison can alert owners to re-evaluate and modify their long range strategic plans to maximize value.
Mary Warmus is a partner with Fort Dearborn Partners & Fort Dearborn Advisors, a FINRA licensed broker-dealer, collectively known as Fort Dearborn. Mary is an Accredited Senior Appraiser (ASA) with a focus in business valuation. Her Practice centers on the valuation of closely held businesses, their valuation of closely held equity and debt securities for transaction, litigation, business succession, restructuring, and transfer pricing purposes.
Mary has over 25 years of experience valuing closely held businesses and intellectual property for tax and strategic business planning purposes. Mary’s areas of expertise include succession planning, ESOP’s, strategic valuation for acquisition and/or divestiture, and business and tax litigation. She has served as an expert witness in both federal and state court. Mary’s principal business valuation experience is in the following sectors: manufacturing, distribution, printing, agriculture, professional services, healthcare, logistics, computer software, computer consulting, and investment holding companies including partnerships. Prior to her career in business valuation, Mary was a tax consultant where she focused on research and compliance issues for various corporations, partnerships and high net worth individuals.
Active in a number of professional associations, Mary participates in the following organizations: American Society of Appraisers; American Institute of Certified Public Accountants; Association for Corporate Growth; Illinois CPA Society and the Chicago Estate Planning Council; in addition to various civic, religious and charitable organizations. Mary is also an adjunct professor at DePaul University teaching the tax valuations course in the Masters of Science in Taxation program.
Mary earned her Master’s of Business Administration from Loyola University of Chicago in 1991 and her Bachelors of Science in Commerce with a major in Accountancy from DePaul University in 1983 and is a Certified Public Accountant. She is an Accredited Senior Appraiser (ASA) in Business Valuation through the American Society of Appraisers.
Mary Warmus, CPA, ASA, MBA – Partner
Fort Dearborn Partners, Inc.
101 North Wacker Drive, Suite 1150
Chicago, IL 60606
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