ValuAdder Business Valuation Blog

Business valuation tips, updates and advice. Pick up a few suggestions on how to value a business. Feel free to browse the contents or share your thoughts by leaving a comment.

A common reason business people need to have their business appraised is gift and estate tax situations. Business ownership grants by living owners to family members trigger a gift tax liability.

If an owner passes away, the business is inherited by other partners or family members. One rather unsavory chore they need to handle quickly is how to pay the very large estate taxes. The tax bite of up to 50% of the business value can be very painful.

Business valuation that holds up to scrutiny by the tax authorities

As a rule, business owners are interested in the highest possible business valuation result. This is certainly true when the company is offered for sale or an outside investment is sought, whether venture capital or debt financing. A partner buy-in is another situation that calls for the highest defensible business valuation.

Valuations for gift and estate taxes are quite different. Since the tax is levied on the current business enterprise value, business owners are interested in the lowest supportable valuation.

If your business valuation is too low, expect the tax authorities to be skeptical. Experienced tax agents are aware that business people want to reduce their taxes. Even if you retain skilled accountants and attorneys, a business valuation that is too low will likely draw the attention of the tax man.

If fact, the tax authorities may come up with their own valuation for your business. You will have to defend your appraisal if their number is considerably higher than yours.

Business valuation standard of value for gift and estate tax appraisals

Fair market value is the typical standard used to value businesses in these situations. The subtle difference you need to know about is that the definition of this standard may differ from that used in business acquisition scenarios.

Specifically, gift and estate tax valuations consider what the business is worth to a hypothetical business buyer without regard to special synergies that could result in a higher potential business selling price. If you plan to use the income based methods such as the Discounted Cash Flow, be aware that conservative earnings forecasts are usually acceptable as long as they are realistic.

Business valuation: points of contention

Business owners, their professional advisors and tax agents usually clash on these points:

Since your business valuation result depends upon a set of assumptions made, tax agents can challenge you on your financial forecasts, business risk estimation, as well as the definition and premise of value used.

Business valuation is about the future outlook of earnings and risk. Will the business revenue continue to grow at the historic 5% a year? Will the industry sector become more risky over the next 5 years?

Will the business continue running as usual or need to exit some markets and drop some products? Will the business need to expend considerable resources to acquire new assets? Depending on the answers your valuation results may vary quite a bit.

Marketability discount and business sales comps

Tax agents usually understand that a private company is harder to sell than shares of stock in a publicly traded firm. The question is the amount of marketability discount applied when valuing a private business based on comparable business sales.

If you have a reliable source of comparable private business sales, you can offer very defensible evidence in support of your business valuation. The guideline public company method is another way to compare your business to similar small to mid-size public companies in the same industry.

Control premiums and minority discounts

This is another common bone of contention between business people and tax agents. An unreasonably high discount for lack of control reduces the value of the business ownership interest – and taxes due.

You can come up with defensible minority discounts by citing control premiums paid by public companies that acquire controlling stakes in other firms. Since public companies must disclose such transactions, you can review the control premiums and calculate a sensible minority discount from these data. Case law in your jurisdiction may shed additional light on what is usually acceptable in gift and estate tax valuations.

Business Valuation using Three Standard Approaches

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