Archive for December, 2011

Curiosity aside, business appraisals are almost always triggered by a pressing need. Business people generally are interested in what the business is worth for these reasons:

  • Business sale transaction, including sale of the entire company or offering a block of stock for sale.
  • The need to raise additional debt or equity capital.
  • Gift or estate taxes.
  • Partner buy-in or buyout of a departing partner’s ownership interest.
  • Litigation such as divorce or shareholder disputes.

In just about all of these situations business appraisal is a zero sum game: one side usually wants a higher result while the other is interested in lower business valuation.

Valuation of a business for sale

If you are a business buyer, you would naturally seek to lower the purchase price, hence the need for conservative valuation. On the other hand, if you plan to sell your business you would be most likely interested in getting the highest price possible for the company.

This adversarial relationship between parties to a business appraisal brings up an interesting question: is there a way to strike a balance between the conflicting interests of the parties involved?

Business fair market value is revealed in the market place

Since it is harder to argue against obvious facts, business people are likely to reach a sensible compromise provided there is sufficient evidence as to what the business assets are really worth. When in doubt, you can refer to the market place. If there are enough transactions involving similar businesses, the prices paid by others serve as a good starting point in your own negotiation.

Sale comparables and business value

The idea is that comparable business assets should sell for about the same price. In the consumer market this is very clearly the case. Consider the prices paid by a dealer for a used auto you offer as a trade-in for a new car. While your objectives and those of the dealer are directly opposed to each other, to make a deal you are likely going to agree on a price that fits somewhere in the range other car owners have accepted.

For a given car brand and condition, there are usually plenty of sales data to go by. So comparable selling prices tend to help you keep your negotiation relatively simple and straightforward.

The situation is similar with business assets. Those that can be easily substituted and sell often tend to have a pretty well defined price range in the market. But if your company owns some highly specialized assets, the situation could be more difficult.

Business valuation: beyond sale comps

The same applies to the business itself. If comparison is hard to make, arguments as to the business fair market value are likely. That is one reason a well considered, comprehensive business valuation is very important. You can demonstrate what the business is worth by using a number of methods, not just the market comparisons.

The more unique the business, the more such considerations as the earnings prospects, unique business value drivers and industry growth potential define its true value.

Business Valuation using a Set of Methods

In most jurisdictions, private businesses are required to pay the so-called ad valorem taxes on business personal and real property. Most business people treat these taxes as a necessary evil – you have to pay them regardless of how well or poorly the company did in a year. You simply have to fill out the local assessor forms about the business property changes, additions and asset retirement, then send in the check.

Interestingly, most assessors do not appraise the business property at its true fair market value. This is a defensive tactic. If a business owner gets a tax bill that shows the business asset values as overstated, he is likely to object to the amount. It is harder to argue if the assessed values are below what the assets are actually worth.

It turns out that the assessed value of a business asset does not matter in so far as the tax bill is concerned. There are two key elements to a business property tax. First, is the assessed value. Second is the overall tax revenue the local government expects to collect. The tax rate is determined based on the overall property valuation and the revenue goal.

So it does not matter if your firm’s assets are appraised at 100% or 50% of their fair market value. The business property tax expense is exactly the same.

Since the tax revenues are split across the entire local asset base, it does matter if your business property valuation is relatively higher than that of other local companies. There are two reasons this may happen:

  • You have overstated the values of your company’s assets.
  • The assessor has not properly equalized the value of your firm’s assets in relation to other companies in the area.

In fact, business property tax bills usually do not detail the equalization rate applied to calculate your firm’s property tax burden. The assessor applies the effective equalization rate to all local companies in order to spread the business property taxes on an equal share basis.

The important part to remember is that the business property values and, therefore, the taxes are based on the asset values your company has reported initially. The assessor then calculates your tax bill based on the these initial asset values along with any adjustments for depreciation and inflation.

One point to bear in mind is that the assessor is unlikely to adjust your business property tax for any economic or technological asset obsolescence.

To minimize your business property tax bill, be sure to report the newly added assets at their true market values. As time goes by, make appropriate adjustments to the asset values as property is being used up and replaced.

Business Valuation Tools