By Michael Alerding There are somewhere in the neighborhood of 77 million Baby Boomers in the United States and studies show that the majority of closely-held businesses are owned by Baby Boomers. For many, their closely-held businesses represent a significant portion of their estates and retirement nest eggs. The question is: What is it worth in REAL terms and not just using a formula designed for taxes or other compliance requirements?
Owners of closely-held businesses have to take into account more than just the concept of Value. They also need to know about how much Time it will take to make the business liquid and receive the proceeds and how much Risk they are willing to take in order to maximize the value. Knowing the value itself is only one corner of the triangle – time and risk are equally important factors to consider when completing this triangle.
Lawyers, CPA’s and other professionals that assist owners in succession planning understand the fundamental difference between a calculated Business Valuation value and the amount for which a business can actually be sold and proceeds realized. When working with owners, in addition to the triangle discussed above, these professionals will often consider other, perhaps more subtle factors, like the following:
- Age and Health of the owner. This can be a very important piece of the triangle because it significantly affects the Time element.
- Customer Dependency. Customer dependency generally affects the Value and Risk elements of the triangle and in many closely-held businesses customer dependency is both a curse and a blessing. If the customer is retained, it is a blessing. If the customer is not retained for a reasonable amount of time after the sale, it represents a significant risk to the seller.
- Management Dependency. Management Dependency issues are quite common in many closely-held businesses because the owners are often entrepreneurs that never lost the entrepreneurial style of managing a business. Accordingly, this issue will often affect both Value and Risk depending on how willing and able the owner is to continuing to work after the sale.
- Marketing Technology. Recently we have seen discounts taken by potential buyers because the business does not have state-of-the-art – or even close to state-of-the-art technology in the business. As more customers purchase goods and services on-line, marketing and technology for on-line sales is a must. The absence of sound marketing and technology will often result in a discount.
- Environmental Threats. Environmental threats can come from real estate issues all the way to healthcare issues for the workforce. Buyers are very careful in their due diligence to ferret out these issues and quantify them quickly. Value can suffer if these are present.
- Size and Footprint. Generally, the smaller the business the more difficult it is to sell and the more discounts will be applied by buyers. Footprint in many industries is critical as well in developing potential strategic values because it saves the buyer from having to grow footprint internally through additional acquisitions. Smaller size and footprint generally affect Value.
All of this reality, however, doesn’t detract from the many benefits of having a business valuation performed periodically, regardless as to where you are in the succession process. Although selling amounts often differ from the values determined in a formal valuation, a periodic valuation can help owners put value in context and provide information as to the steps that need to be taken to maximize value at the right time and for the right purposes.
Having a business valuation completed may identify discounts that will reduce value and provide the information necessary to mitigate these discounts over time. The valuation will also provide some indication of timing as far as gifts or a potential sale of the business. It is not unusual, for example, for owners to make gifts to family and others during those periods when the business, the economy or the industry is not performing well. On the flip side, an owner may want to sell his business when values are highest and discounts have been mitigated – then a formal valuation provides context for both of those decisions.
Formal business valuations are also helpful in certain specialized situations, including the following.
- Mergers and acquisitions
- Buy/sell agreements
- Fairness opinions
- Shareholder transactions
- Capital infusions
- Employee Stock Ownership Plans (ESOPs)
- Employee benefit plans
- Estate planning
- Solvency/insolvency opinions
- Collateral valuations
- Purchase price allocations
- Charitable contributions
- Eminent domain proceedings
Periodic business valuations provide an excellent and cost-effective solution to those business owners who are moving toward succession or who are interested in measuring the continuing value of their businesses. Contact Alerding CPA Group to discuss your needs and to learn about the valuation alternatives we offer to closely-held business owners. Alerding CPA Group is an Indianapolis-based public accounting firm. Visit our website: www.alerdingcpagroup.com.
This post was written by:
Michael Alerding, CPA
Mike has over 40 years of experience in public accounting. He is a prior columnist for The Indianapolis Business Journal and serves on multiple boards throughout Indianapolis. He currently focuses his time on litigation support, business valuations, succession planning consulting and audit and accounting engagements.
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