Is a professional business valuation in the best interest of your client? A look at the factors that should be considered in determining whether or not a business valuation is necessary.
By Alexandria Luppi and Katherine Puffer, VH Valuations
When assessing the value of a business, how can you know if a professional business valuation is necessary? The answer, as always, is “it depends,” but there are a number of factors that should be considered during the decision-making process, including the purpose of the valuation, the profitability of the business, the size of the company, and exceptions. Below we will endeavor to provide some guidelines to assist you in determining if a professional business valuation is prudent.
Reflect on the Reason for the Valuation
First to be considered is the purpose. Valuations can be done for divorce, estate planning, mergers, acquisitions, and tax purposes among other reasons. The IRS typically prefers a neutral valuator for tax purposes and therefore it is generally in the client’s best interest to have a professional valuation done. When a merger or acquisition is contemplated, a business valuation will typically be in the client’s best interests as it provides a realistic starting point for negotiations and assists in determining an appropriate price. Additionally, a valuation may be useful in determining the value of potential synergies when a specific buyer is contemplated. Divorce and estate planning are less clear-cut and, thus, considering the profitability of the business is helpful in determining the necessity of a valuation.
The Influence of Business Profitability
The profitability of the business is a key determining factor in deciding if a professional valuation is in the client’s best interest. As a guideline, if the company’s net profit is breakeven or below after adjusting the owner/proprietor’s salary to market levels, adjusting rent to market levels, and removing any discretionary (non-essential) expenses, then a valuation may not be needed. If the company’s profit does not exceed breakeven after adjustments, it is possible that the business may be more of a job for the owner than a company, in practice. However, a valuation may be warranted, even if profitability is breakeven or lower, if the company holds measurable assets including, but not limited to, accounts receivable, inventory, and equipment. With respect to estate planning, the value of the total estate would have to exceed the lifetime gift exemption ($5.43 million for an individual and $10.86 million for a couple in 2015 per Rev. Proc. 2014-61 Section 3.33) for all beneficiaries to warrant a valuation.
The Three Options for Valuation
It should be noted that, when considering a valuation for divorce, there are three options: no valuation, one neutral valuation used by both parties, or two valuations with one done by each party. In most cases where a valuation should be done (see discussion above), a single business valuation should be considered. Obtaining a single neutral valuation rather than two valuations presents a material cost savings. When two valuations are done, not only do clients have to pay twice to value one company, but they also have to pay for the subsequent hours required to come to consensus from the two invariably different valuation conclusions. Therefore, in most cases, it is in the client’s best interest if the attorneys can agree on a single valuator. You should note that in collaborative divorce, where the financial work is done by a neutral, two valuations generally are not necessary.
Will Hiring a Business Valuator Benefit Your Client?
As with all things, there are exceptions to the rule. The client may be best served by hiring a business valuator, even if that will result in two valuations, if:
- The client believes that there may be fraudulent expenses or unclaimed revenues associated with the business. In this case, hiring both a forensic accountant and a business valuator should be considered. A forensic accountant would be best suited to locate any fraudulent activity and a business valuator can then work toward determining the value of the company had the fraudulent activity not taken place. Note that engaging a forensic accountant can be costly and, due to the nature of the work, they may or may not be able unable to uncover any or all fraud.
- A valuation has been done and the client doesn’t feel the value conclusion is neutral.
- The client is uncomfortable with the neutrality of the chosen valuator.
- The company is very large and there are a number of material qualitative factors associated with determining the value.
If a company is small or unprofitable, but the above factors are relevant, then it may be in the client’s best interest to request a brief report from a valuator. Sometimes brief summary reports are more cost effective and may meet the client’s needs.
There are several key factors that should be evaluated in order to determine whether a business valuation is necessary, including the purpose of the valuation, the profitability of the business, the size of the company, and the presence of any exceptions to the standard guidelines. Assessing these factors as the first step in your decision-making process should be helpful in assisting your client to judiciously allocate resources. A professional business valuation can be a material cost; however, when used appropriately, the benefits can dramatically outweigh the costs. Therefore, it is in the client’s best interest to carefully evaluate when to request a professional business valuation and whether a neutral valuation will suffice in place of two valuations.
Katherine Puffer has over 30 years of business experience and is the owner of VH Valuations. Accredited in Business Valuation by the American Institute of Certified Public Accountants, she is also a Certified Property and Casualty Underwriter and a Certified Divorce Financial Analyst. Alexandria Luppi, a team member at VH Valuations, has a strong banking background and is a Certified Valuation Analyst Candidate. www.vhvaluations.com