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Fall 2015
53
Know Your Value
“If business schools could
offer just one course, it would
not be on stock trading, the ef-
ficient market hypothesis or
modern portfolio theory. Rather,
B-schools should be encouraging
students to learn the boring, but
critically important, discipline of
business valuation.”
– Warren Buffet, 2012 Berk-
shire Hathaway Annual Meeting
Every business will require
a valuation at some point in its
business lifecycle. The reasons
that prompt a need for a busi-
ness valuation vary from tax and
non-tax reasons as well as volun-
tary and non-voluntary reasons.
It is important for business own-
ers to understand the need for
business valuations and, more-
over, the principles of business
valuation. From here, the owners
can better understand that value
of their business, plan for the
growth of the business and ex-
ecute their exit plan strategy.
Many business owners per-
ceive a business valuation may
be required if they sell their
business or their ownership inter-
est in their business. Of course,
upon the sale proposed sale
or transfer of the business or the
ownership, a valuation is sug-
gested as the buyer of that busi-
ness or interest will likely conduct
its own valuation. But also the
business may need to seek a loan
or similar financing at some point
in itslifecycle, and the lender
ill ee t value the enterprise.
Similarly, if the company seeks to
raise capital, a business valuation
is suggested in order to support
the terms and the promised re-
turns of the company’s offering.
Other businesses may want to
institute deferred compensation
arrangements with its key people
in the form of stock apprecia-
tion rights, phantom stock, or
options in order to provide ad-
ditional financial incentives. Here,
the business and the plans will
need to have a baseline value to
use in the calculation of the de-
ferred compensation, as growth
can only be measured if there
is a known starting point. Also,
ESOPs are required to have a
valuation each year.
Estate planning for business
owners is of key importance as
the business owner will someday
retire or leave the business, and
family members may need to be
considered. Here, a valuation of
the business will be required for
estate tax forecasting. Further,
the IRS will have an interest in
the value of the business or the
ownership upon the transfer from
one party to another whether in
a sale, gift or estate transaction.
In addition, unfortunately dis-
agreements among the owners
of a closely held enterprise may
lead to owner disputes and the
need for a business valuation in
any buy-sell arrangement or in
any litigation that may arise be-
tween the owners.
For exit planning purposes, a
current business valuation helps to
identify what reasonable exit ob-
jectives are achievable, what driv-
ers need to be in place to achieve
those r sults, and r vides a guide
to keep the business on track to
build value and execute its desired
exit strategy. All exit plan suc-
cess starts with a beginning value,
which a valuation provides.
The business valuation pro-
cess has its origins in an IRS Rev-
enue Ruling from 1959. In this
ruling, it was determined that the
date of the valuation, the valu-
ation’s purpose, the premise of
value considered in the valuation,
and the standard of value to be
applied – fair market value, fair
value or investment value – are
vital fac
tors in the business valu-ation process. From here, the fac-
tors that are viewed to strongly
determine the value of a business
in the valuation process include
the history and nature of the
The boring by critical importance of business valuations
By
Philip
Josephson
Scenarios That Can Require a Business Valuation
Voluntary
(Actions that a business
can make happen)
Involuntary
(Actions that can occur
to the business)
Outside capital
Exit planning
ESOP, Compensation plans
Earn outs
Transfer to family/insider
Sale or purchase
Death
Divorce
Bankruptcy
Owner dispute
Forced restructuring