By: Joel B. Charkatz, CPA, CVA, CFE

How much is a business worth? The easy answer for most business owners is, “Everything.” Everything revolves around the business, and the business always comes first.

But the truth is that the actual value of your business changes throughout its life. Businesses that are just getting off the ground may have little or no value from a financial standpoint, but try telling that to the owners who have poured their blood, sweat, and tears into making their dream a reality.

Then there are businesses that have been around for awhile and have built a track record. They have tangible worth in that they have accumulated tangible assets such as computers and office equipment, inventory, real estate, and who knows what else. But they also have intangible value – namely, the clientele they have developed and the goodwill they have generated.

The bottom line is that business owners should constantly be aware of the value of their business. This is particularly true in the case of small businesses which – while undoubtedly a driving force in the economy – are particularly vulnerable. Small businesses often thrive from the hard work of friends and family. As a result, they can be particularly susceptible to serous peril from everyday occurrences, such as partnership disputes, divorce, retirement, economic changes, and so on. Makes you wonder if all that work is worth it.

Even if the company’s future is not in jeopardy, clear and accurate business valuations are critical for mergers and acquisitions, shareholder transactions, sales and divestitures, capital infusions, buy-sell agreements, estate planning & taxation, charitable contributions, purchase price allocations, and assessment of gift taxes (just to name a few reasons).

One of the best ways to protect both the business and the sweat equity that went into to it is to keep on top of what it is worth from the day it begins operations and throughout its entire lifecycle, with special attention during critical stages (expansions, mergers, etc.).

A credentialed financial professional, such as a Certified Valuation Analyst (CVA), typically handles valuation of a business. But business valuation is not – or perhaps should not be -- strictly in the purview of the professional. As a business owner or advisor, there are things you should know and questions you should always be prepared to ask whenever situations arise that could impact the value of a company.

This article is the first in a series from a forthcoming book about Business Valuations. In both the book and the articles, we will discuss the key elements of business valuations, including techniques and processes for valuing a business, saving money through proper valuations, examining valuation reports for loopholes, and much more.

THE NUTS AND BOLTS OF VALUING A BUSINESS

Whenever valuing a business, many times the goal is to obtain or determine fair market value. That value is defined as the price at which property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.

The Internal Revenue Service determined this definition in 1959. More than forty years later, it is still considered the most informative and eloquent definition of fair market value.

Typically, a business has two types of assets which require determination of value: tangible and intangible. An independent appraiser should appraise tangible assets, which include the value of equipment, buildings, vehicles, etc., if those assets are material to the valuation.

Intangible assets, however, are trickier simply because they are more abstract. In theory, intangible assets can include intellectual property such as licenses, trademarks, patents, and copyrights, which may also require an independent appraisal. In many businesses, however, the intangible asset of greatest value is the goodwill a business has built up over the years. While the definition of goodwill is somewhat elusive, several significant (and concrete) factors do enter into the determination of goodwill, including anticipated future earnings, level of competition, economic strengths, price charged for services of products (compared to others), location of business, and employees of the business. These factors are recognized to bring a business profits just as much as the product or service a business sells.

Various premises of value also must be considered whenever a valuation of a business is performed. Is the business to be valued based on the fact that it represents a going concern or is the goal of the valuation to determine the value if the owners are to liquidate the business? Is a controlling interest in the business being valued or a minority interest? To what degree is there a ready market for the business that is being valued? How about a market for a minority interest in the business? These so-called “premises of value” are assumptions as to the set of circumstances under which the valuation will occur. The premise of value will define the conditions under which a buyer and a seller will exchange the assets, properties, or interest in the business at hand.

The purpose of the valuation may also affect the determination of value. A valuation for a purchase or sale is subject to all of the forces that affect supply and demand, including all relevant economic factors prevalent at the time (think dotcoms in 1999 vs. at least some of those dotcoms today) and any other factor which influences the market for the business in question. Valuations prepared under this premise may have a goal other than fair market value.

A valuation of a partial interest in a business, however, may or may not determine a value which represents the proportionate share of the total entity. In other words, depending upon the circumstances, the sum of the values of the various parts taken individually may or may not add up to the value of the business if it were valued as one total entity. If an individual wanted to sell his or her 15% minority interest in a business, for example, he or she might very well realize something less than their proportionate share of the total entity value.

Although the standard of value for estate, gift and inheritance taxes is fair market value, there can be marked differences between a valuation for tax purposes and a valuation for a sale of a business. Estate and gift tax valuations, for example, are based on the value of a business to a hypothetical buyer who would have no special synergy with, or relationship to, the seller. In a valuation for tax purposes, though, the fact that a seller might be able to command a higher price because of some feature that might be uniquely valuable to a particular buyer would not be considered.

Remember the question to ask yourself is not why should a company be valued, but rather how much is lost by not knowing an organization’s value today, tomorrow and for years to come?

Certified Valuation Analysts Joel Charkatz, along with James Sandkuhler, chair the Business Valuations practice at the accounting and consulting firm KAWG&F. For more information, contact them at 410-828-CPAS or email Joel at jcharkatz@kawgf.com.