What's your business worth? Don't rely on your own guess

As the owner of a closely held business, you may ask, "Why do I need an expert to place a value on my business?"

After all, who is in the best position to place a value on your business, some outside expert who is analyzing its financial statements and operations for the first time, or you, the owner who has nurtured and grown the business and lives with it every day? How can anyone believe someone else would know the value better than you, the owner? And to add insult to injury, you have to pay the expert to come up with a value that you already know!

Know what? You are right. You are also wrong. There are many reasons for valuing a business, but probably none as important as gaining an independent perspective. While you may know your business better than anyone, the perception from the public, the government or other users of the valuation is that you as the owner have a vested interest in the value. Based upon your bias, you may skew the value too high or too low depending upon the purpose of the valuation.

The bottom line is that the appraisal the expert places on your business should confirm the value you have in mind. The difference is that the analysis performed by an outside expert is independent, and therefore adds validity to the value.

The primary reason for valuing a business that comes to mind for most is the sale or purchase of a business. A business valuation can be performed to assist the owners in targeting a beginning negotiation price or to assist potential buyers of a business in assessing the acquisition price and corresponding capital or financing required.

Another significant need for business valuations is in the estate and gift arena. When a closely held business is included in the estate of a decedent, Internal Revenue Service rules and regulations must be followed to value the business for estate taxation purposes. Similarly, in the course of estate planning or in charitable giving, gifting of ownership in a closely held business requires a business valuation to adhere to IRS regulations and court cases.

Since the main concerns in the estate and gift arena of business valuations is the desire to avoid costly tax litigation and reduction of estate income taxes, the IRS is usually careful in scrutinizing estate and gift valuations of closely held companies and looks to independent valuations for acceptable methodologies, the application of reasonable discounts and other items affecting value.

Another significant, recurring reason for business valuations is their application to buy/sell agreements among partners in a business and the employment separation of a partner (for retirement, termination, moving on to another job or other reasons). Valuations for buy/sell agreements may be performed in a number of ways, based upon methods stipulated in the agreement or call for an independent appraisal.

Unfortunately, though many businesses initially draft a buy/sell agreement, the agreements often do not allow for properly updating the value as the business changes. Since a buy/sell agreement is important in facilitating the orderly transfer of ownership from one party to another at an agreed price, the absence of an agreement (or an improperly prepared agreement), leaves the existing owners to negotiate the value, often resulting in disputes or litigation.

Valuations can be prepared as a result of one of the triggering events or as a general management tool to provide management with independent information that helps them identify strengths and weaknesses that affect value. The insightful information from an independent valuation can allow management to more effectively focus its energies in places that really count -- areas that drive value in the business. As such, valuations can be prepared as often as annually, or more likely, every couple of years as a measurement tool.

So here is the wakeup call -- valuations can and should be used at key stages in the development of a business and in the development of the owners' personal estate and gift plans. The owners' opinions are prejudiced and biased due to personal involvement and "rules of thumb" in industry just don't cut it.