Looking at some of the most common scenarios that necessitate a valuation, you will be able to identify when it might be time to get one for your business. Here are 10 key reasons you might need one:
1. Succession Planning
One of the important steps in succession planning is to know how much the business is worth for a transfer of ownership. Whether you give it to family, sell it, or hand it over to employees, the first thing you should do is get the valuation done.
Selling a company to a strategic buyer usually gets you a higher price than transferring it to a family, employees, or someone with no connection to the business. By combining certain overhead costs, the buyer will be able to improve profit and cash flow and integrate the income streams into their current company.
2. Estate & Gift Tax
A business valuation may be required when you are submitting an estate tax return and helping the personal representative manage the will. A thorough estate and gift tax valuation helps you follow tax rules and get your reports right.
Evaluating a company or business interest can help lower estate tax liabilities, especially with federal and some state estate tax laws in effect.
3. Sales, Mergers, and Acquisitions
A business valuation is crucial when a company is involved in a sale, merger, or acquisition. Both the buyer and seller use it for restructuring, bankruptcy, or capital reorganization, so both sides may need a valuation.
In mergers, both parties generally need respective valuations to address potential problems, such as calculating cash equivalents in stock-for-cash exchanges.
4. Buy or Sell Agreements
A company may need to do a valuation first to create a buy/sell agreement. These contracts can also be designed for business or tax purposes. To maintain an accurate value for estate and gift tax purposes, a valuation may be requested if related parties are involved in the sale. If an owner of a closely held company is retiring, leaving, or passing away, the buy/sell agreement provides an option for another owner to buy their interest.
These agreements often include a lump sum or formula that the other owners must pay to acquire the share of the departing owner. To track the company’s performance periodically, this pricing or formula needs to be reviewed, say, after a specific period of time by an valuation expert.
5. Shareholder and Partnership Disputes or Buyouts
Disputes may derive from owners’ conflict, issues connected to the merger/splitting of ownership, or other issues related to ownership.
Businesses can reorganize, dissolve, or merge without the approval of all owners in a majority of states. This could lead to a disagreement that needs to be valued in order to be settled.
6. Allocation of purchase price (Tax & Financial Reporting)
When a company is sold, merged, or acquired, both the buyer and seller should carefully keep track of the sale. Inappropriate and inconsistent distribution of the purchase price may result in higher tax obligations and even penalties.
A valuation analyst will assess the distinction between business and personal goodwill, while also considering relevant state laws that affect these transactions and their tax implications.
7. Marital Dissolution
It may be necessary to do a valuation in order to divide the marital estate when a private business owner gets divorced. There is a growing trend toward collaborative divorces, where the parties agree to engage a single valuation consultant, but typically, both sides acquire separate valuations.
8. Insurance Purposes
Owners of closely held companies will occasionally seek a valuation to determine the value required to protect their company interest value in the event of an emergency. Then, “key person insurance” is obtained for this value.
In an emergency, the owner’s family may receive enough support from the insurance to continue with the owner’s responsibilities or to buy themselves out of them. The conditions of the key person’s insurance policy and buy/sell agreements apply to these regulations.
9. Financing/SBA loan
Financial institutions and the SBA may demand a business valuation when purchasing a firm or a business interest to underwrite and approve a loan.
Financial statements are usually provided at a historical cost. The bank will receive fair market value amounts from a valuation to support a loan.
10. ESOP
An Employee Stock Ownership Plan needs an annual valuation in order to determine the share price for plan participants. This valuation is needed for compliance with IRS and Department of Labor regulations and makes sure that ESOP beneficiaries receive the stock’s fair market value and protect the trustees from possible liability.
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