The state of today’s economy makes it more important than ever to know an independent third-party’s value of your business.  Antiquated formulas and unsophisticated methods of the past may not result in accurate business valuations, whether it is for estate planning, buyout agreements, shareholder disputes, sale of a business, shareholder/marital disputes, or life insurance.  A company’s shareholders and/or management should seriously consider obtaining a valuation on a regular basis in the interest of avoiding a potential monetary quarrel with the IRS or fellow shareholders.

The most common method used to valuate middle-market businesses utilizes an estimated rate of return (ROR).  Investors typically require such businesses to go through an estimated ROR analysis in order to determine if a company is a viable investment.  A valuation provides an objective estimate of a company’s value based on a variety of qualitative and quantitative factors, which allows an investor to determine a fair rate of return required for the investment.  Simply put, a high risk investment will result in a higher rate of return required by an investor.
In the finance industry, as well as the valuation industry, the lowest (and safest) rate of return has historically been the United States’ 20-Year Treasury Bond yield.  The U.S. “debt crisis”, political impasses, and the U.S. sovereign debt downgrade, and potential future downgrades, may cause discussion as to the applicability of this assumption.  The question as to a “safe rate” of return is but one reason why formulas or multiples, without further analysis, may not result in an accurate value of your business without a formal valuation.

The existence of buy-sell agreements is one important reason to have an updated valuation.  Traditionally, individuals enter into buy-sell agreements to financially protect a group of shareholders upon the death of one or more other shareholders.  Unfortunately, many shareholders fail to realize the consequences of entering into a poorly written buy-sell agreement because there could be a lack of transparency between the shareholders and the IRS.  Under certain circumstances, a stock transfer under a buy-sell agreement’s legitimacy could be challenged by the IRS.  As a result, the buy-sell agreement may trigger a gift or estate tax due to the IRS’ assertion that a business’ agreed-upon value was not its fair market value.  To reduce the likelihood of this potential outcome, shareholders should have a valuation performed on a regular basis so that a company’s fair market value is current and defensible.
Business disputes and dissolutions are another reason to have an updated valuation. Similar to a marriage, most business partners who form a business together do not expect to split up.  Nevertheless, company shareholders frequently decide to go their separate ways.  If a company has valuations prepared on a regular basis, all shareholders will know the current value of their individual shares.  This mitigates the potential heartache and costs that shareholders may incur with a shareholder dispute.

In summary, a business valuation gives shareholders the opportunity to prepare for the unexpected and protect the future of their company.  We live and operate in an uncertain world and put a premium on clarity since so much of our daily activities are out of our control.  If you have not obtained or considered obtaining a current business valuation, you may want to act before the unknown occurs.