Reasons For Valuations

There are many reasons why a business owner may require a business valuation:

  • To find out what your business is really worth. This is particularly valuable information if you are thinking of doing any kind of transaction, such as raising capital, borrowing money, or selling your business. Some business owners have insufficient information or unrealistic expectations with respect to the value of their business. Having this feedback may save you hundreds of staff hours (including your own time), legal fees and accounting fees in preparing and negotiating a transaction that is likely destined to fail. It may help avoid sharing confidential information with investors, only to be later disappointed by a transaction aborted due to a valuation gap between buyer and seller.
  • Fairness opinions to support transactions. When you are negotiating a merger, next generation transition, selling to key employees, or undertaking certain types of corporate reorganizations, tax planning as well as legal contracts will require a value to be set on your business.
  • Divorce. A marriage dissolution is unfortunately a frequent trigger of business valuations, as part of splitting the family estate.
  • Death. Loss of a shareholder may trigger a business valuation, in order to calculate the basis for inheritance or estate taxes.
  • Bonus plans. Some bonus plans of private companies are tied to business valuations. A good way to motivate staff is to provide them with a percentage of increase in corporate value.
  • Employee Stock Ownership Plans (ESOPs). A business valuation may be used to set up an ESOP, and many firms that operate as ESOPs perform a valuation annually, to measure milestones, productivity, or establishing a price for entry or exit from the ESOP.
  • Partnership changes. Adding a partner or buying out a partner usually requires a business valuation.
  • Tax and estate planning. Certain sophisticated estate planning vehicles such as “estate freezes” require business valuations.
  • A learning experience. A good valuation will help an owner better understand value drivers of their business, as well as how investors or a buyer will be likely to perceive the business.

Premise of Value

When having a valuation done, one must set the premise and standard of value.

The premise of value sets important benchmarks such as:

  • Valuation date: this sets the effective timeline of the valuation;
  • Valuing the business as a going concern or liquidating the business;
  • Valuing the assets of the business or the equity capital of the shares of the business;
  • Valuing all or part of the business due to shareholder breakdown.

The standard of value is also important. Generally it makes sense to value a business using fair market value.