Mirror, Mirror on the Wall:
Is My Business’s Value
Fairest of All?
Maximizing the Fair Market Value of Your Business
As a business owner, when you look in the mirror, what do you see regarding your company? Most, if not all, owners personally place a high value on their businesses. This fact is not a surprise when thinking about it through the eyes of an owner. For starters, the business could have been developed from an idea that started in childhood, a thought derived in college with a number of friends, or an inspiration sketched on the back of a cocktail napkin. The business owner may have contributed significant capital to the company, even to the point of utilizing guaranteed retirement savings and personal reserves. In turn, the owner will likely believe his/her business is worth significantly more than has been put into it.
Through the eyes of the owner, the business is truly a member of the family, in essence, the owner’s “baby.” That being said, how does an owner translate their perception of fair market value into reality, with reality meaning maximizing the potential fair market value of the company?
There are a number of issues for owners to consider when attempting to make the value of their business the fairest of them all. Let’s examine these issues to make the image in your “valuation mirror” as clear as possible.
What Is Fair Market Value?
The fair market value of a business is generally based on the criteria set in IRS Revenue Ruling 59-60. Revenue Ruling 59-60 holds that fair market value equals how much your business is worth if it were to transition “between a willing buyer and willing seller” without compulsion to buy or to sell, with both parties possessing “reasonable knowledge of all relevant facts.”
In reality, the standard set by Revenue Ruling 59-60 only projects a small part of the image you see in the mirror. Guidance from an expert regarding valuation relative to the market place will clarify the image you seek. Instituting a program focused on “value drivers” will not only protect the way your business currently looks, but will also improve the vision seen.
Your Guidance Search: So Many Experts, How to Choose?
There are two basic approaches to consider in regard to which type of expert should value your business in an effort to determine fair market value. The first approach is informational and applies to an owner who wants to know how much the business is worth from an academic or tax standpoint. Under this approach, you can personally apply a recognized valuation method—examples include a multiple of income or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)—based upon your industry. A more detailed analysis can be completed by a valuation specialist who is independent from the company being valued. This specialist should be designated as a qualified business appraiser, preferably with an AVA (Accredited Valuation Analyst) designation.
The second approach is a method for a business owner who has considered or is contemplating marketing their company for sale. A valuation performed by an investment banking or capital markets firm may likely provide the benchmark necessary to determine where the company’s value is relative to similar companies at this point in time. From this benchmark, the firm will likely put into place a plan to market the business through direct sale or auction in an effort to maximize return on investment and value. The firm chosen should have significant experience in numerous industry sectors and have professionals you feel comfortable working with.
Focus on Value Drivers
Simply put, value drivers are intangibles that a business owner can solidify within the company in an effort to improve its fair market value. The importance of a specific value driver will vary based upon the type of business, its size and transition goal. A business transition strategist can assist in identifying and helping you put a plan in place to address which issues are most important for you to focus on based upon your goals and objectives. Following are four value drivers and their importance to the future value of your company:
- Contingency Planning – If your business does not have a contingency plan in place, it will likely decrease significantly in value if an unexpected event were to occur. Examples of an unexpected event include the death and/or disability of an owner or departure of a key employee.
It is important for a business to have a plan that addresses which people will maintain specific responsibilities in a time of crisis, with whom control will reside if a transfer of stock were to occur, and how to access liquidity if the business needs capital quickly. A well-crafted and executed contingency plan will provide potential buyers a sense of confidence when considering a purchase of your business.
You may also consider having the company own a key man life insurance policy on each of your key people to provide liquidity to recruit and train a replacement employee in the case of death.
- Retention of Key People – The value of a company lies not only in its bricks and mortar but also in its people. Potential suitors for your company often look at the people it will be inheriting in a purchase to ensure they will reach the return on the investment they wish to achieve. The best way to protect your key people is to first identify who they are. Then, sufficient key employee benefits should be put in place to ensure your key people would not want to leave your company for a better opportunity. Key employee benefits are offerings made by your company in addition to any current benefits that all employees receive.
Examples include the institution of an executive bonus plan, nonqualified deferred compensation or equity-based compensation such as restricted or incentive stock options. You may also offer an additional insurance benefit through a split-dollar program which allows your key employees to receive coverage for their family for potentially a reduced out-of-pocket cost, with your company ultimately receiving reimbursement for the insurance.
- Business Factors – There are numerous business factors you may consider in an effort to enhance fair market value. Here are eight questions focusing specifically on factors which may impact your business value:
- Business Formalities – Does your business follow necessary formalities from an asset protection and industry specific standpoint?
- Employee Errors – Have you put into place procedures to minimize employee errors?
- Competition – Have you attempted to minimize your vulnerability to competitor risk?
- Technology – Have you sufficiently invested in technology (as necessary, based upon your industry)?
- Defining Success – Can you define what success means to you and illustrate it to a potential buyer?
- Productivity – Is employee productivity a concern of yours and can you measure it?
- Diversification – Have you adequately diversified your customer base?
- Facilities Management and Risk of Loss – Are you susceptible to financial loss from the facilities that the business currently inhabits and how the risk is managed?
- Family Dynamics – If your business is closely held and operated by family members, it is important to consider the relationship between each family member employed by the business and what their role with the company will be as you attempt to grow the company. Placement of the wrong person in a key role will likely hinder business value because there is a greater likelihood that the family member will stay in that position to maintain family harmony. Likewise, a “unified front” regarding the future transition of the business may improve business value due to a lack of conflict when the future transition occurs, especially in cases of a third-party sale.
As you see, there are many pixels that create the full image of the fair market value of your company. A valuation measurement based upon industry-specific expertise provided by a specialist or capital markets firm, coupled with attention paid to specific business issues – namely value drivers – may propel fair market value upward if executed correctly. An approach to solidifying fair market value as discussed will allow you to ask the mirror your question with confidence. And depending upon your goals and objectives, you may just like the answer you hear in return.
BB&T and its representatives do not offer tax or legal advice. Please consult your individual tax or legal professional, in conjunction with your BB&T Wealth Management Advisor, regarding your personal circumstances.
This article originally appeared in the Spring 2012 issue of Wealth magazine.