Business Valuation Blog | Understanding Buying / Selling a Company

Transferring ownership of the family business requires care and planning to ensure a smooth change of leadership. One frequently overlooked tool that can assist in the transitioning of the business to family members is a company valuation. Learn how getting the family business appraised can benefit all the relatives and related parties who work for the company.

Why You Should Obtain the Valuation Before Transferring Leadership

Imagine if you transferred the family business over based on a “ballpark” value thrown out by one or more of the current members involved. Older relatives who held leadership positions might be expecting a large payout. Others may have assumed the payout was certain and planned their retirement lifestyle on it. When the valuation of the company is not formally established by a certified independent appraiser when leadership transfers, the grounds might be set for a generational dispute if there is no real agreement or understanding of the true value.

If you engage the services of a business appraiser, the resulting analysis and report would act as an objective neutral framework for the company that would guide all the family members involved. While the appraised value might fall short or potentially be higher than the perceived value, the process of getting the business appraised will take some of the emotions out of the leadership transfer.

Once everyone understands the true worth of the company, you can allocate the fair market value by the number of shareholders, and provide the owners with an idea of their retirement income, and plan for the next steps with the transfer of the business.

The appraisal can also help manage expectations and allow the new leaders to chart a course forward with confidence that they have all the facts needed to succeed. Instead of causing strife, the change of leadership can now strengthen family unity.

Getting Family Business Appraisals for Tax Purposes

Not only is it important to have the company appraised from a personal perspective, but it is also necessary to do so for tax purposes. The IRS requires that businesses not subject to a special provision be valued at "fair market value" for federal tax purposes when the business is transferring family leadership. Fair market value denotes the price that a buyer, not related to the willing seller, would reasonably pay for the business. Since most company owners cannot objectively determine fair market value, a business appraisal will solve this requirement.

If the IRS were to ever examine the business transfer or audit company taxes, the appraisal can prove that the company's value was treated as "fair market" for the purposes of transfer.

If you sell the business to your relatives for less than fair market value, the new owners could be penalized with gift or estate taxes. Selling for fair market value is the best way to avoid this and ensure a smooth transfer of ownership.

Planning Your Business Appraisal

Now that you are aware of how a business appraisal can assist with the transfer of your family’s company, take action by finding a qualified appraiser. It is well worth the time spent to find an appraisal professional who understands your industry and your geographic locations, given that these two variables can directly affect the company's appraised value. A certified business appraiser will also have the experience and credentials needed to support their value conclusions.

Business Valuation Specialists can assist you in this process from beginning to end. We have the qualifications you are looking for and the experience you need to provide an accurate appraisal that will help you through the transition process.

Whether you've put serious work into building a legacy for your children or are inheriting a business that has been passed down for generations, family businesses provide strong ties and require dedication from one generation to the next. That aspect of the business means that valuing a family owned business must be undertaken with a focus on the family, reputation in the community and many other facets to develop a true determination of business value. Here's a look at the differences that must be considered during the appraisal of a family business.

How valuing a family owned business is different than other business appraisals

Initially, differences in valuing the family business will depend strongly on the reason for the valuation. Is the business being sold to another family member? Will it be a gift to heirs? Are you trying to get ahead of potential estate tax issues that could arise? Is key personnel insurance being considered in case a particular individual dies or is incapacitated before the next generation can take over? There are many different reasons for getting a business appraisal which can impact the type of appraisal performed.

For many situations, fair market value is used to determine the business' value. This provides a fair distribution of the tax burden between the existing owner and the future owner of the business. It's also one of the most commonly-used approaches to valuing a business. However, in some situations, future income levels may be considered in a business that is currently growing. A good example of this is for key personnel insurance, where that individual is vital to the continued growth of the business. If that individual was incapacitated, it may cost the business future income, so it's important to own a policy that meets those future expectations.

Another area where a family business is different that a regular business is in community reputation and goodwill. Because a multi-generation business typically has some significant amount of history, it often has built significant goodwill in the community. The reputation that has been built over the decades and the existing consumer base will provide a new owner with a great deal of leverage as compared to a relative newcomer in the community. This reputation and goodwill must be taken into account during the valuation process to ensure the full value of the business is calculated.

Because family businesses are passed from one family member to the next, it's generally expected that the business will continue to see strong performance in the industry. When compared to the general uncertainty of a business that is being purchased by a stranger, family businesses are typically much more stable. Knowing that the business will stay within the family reassures customers and investors that past performance levels will be retained into the future, building confidence in the company and ensuring a promising tomorrow.

Valuing a family owned business requires a special skill set and knowledge so that the unique facets of that business are acknowledged during the process. A certified business appraiser has spent a significant amount of time being trained in aspects of company valuation using standardized methodologies in the process. If you're considering having a business appraisal completed on your family business, make sure your appraiser has certification and is experienced in appraising in family businesses.