The most common reasons for valuing a business is when you are buying or selling it. This article discusses the other reasons you may need to value a small family business and how important it is that you know and understand the valuation process and are closely involved.
Changing The Structure
Where you are changing the structure of you business from, say, a sole proprietor to a corporation or partnership, some states require you to pay a duty on the business transfer value. In this case an independent valuation may be required.
In the case of a split up with a business partner either you are buying their share or they are buying yours. A realistic valuation that is easily understood should lead to much less acrimonious negotiations.
In the case of a divorce where the business is being retained by one of you, it needs to be valued to be included as part of your combined estate as part of the settlement.
If you are retiring you should always do a valuation on passing on the business to your children. The only exception to this is if you only have one child to pass it on to and you see it as a gift – but even then you may have to value it for gift tax purposes.
Otherwise, doing a valuation will save you a lot of grief. If the business is being sold to one or more of your children and you intend to have them repay you on a long-term basis as your retirement pension, then you (and they) obviously need to know how much to repay you and on what basis.
Vendor Finance And Bills Of Sale
Selling the business to your children this way is a form of Vendor Finance. Instead of your children having to go to a bank to borrow the money to buy you out, you in effect provide then with long-term finance. In this case you are dependent on them repaying you and are highly vulnerable if they don’t.
To protect yourself you should always take out a Bill of Sale over the business. This prevents then from selling or mortgaging the business without your permission and allows you to repossess it if they fail to keep up with the repayments.
I might sound like a harsh son-of-a-bitch, but you would not hesitate to do this if you sold to a stranger on a vendor finance basis (and this is common in some countries). There is no reason for your children to take offence at this, for they are getting a business handed to them without them having to approach a bank and in all likelihood mortgage their homes.
Gifting The Business
If you are gifting the business to one or more of your children, it is only fair on the rest of them that they know how much the gift is worth so it can be factored into your will. Even if you are gifting it to all of your children equally, a valuation allows one or more of them to have a “get out” figure if the business does not suit them. In some states it may be compulsory to have the business valued for gift duty purposes.
What Has To Be Valued
Where a business is being bought or sold it is usually only the net tangible assets and goodwill that are valued. There are no set rules however. Sometimes the vendor may want to keep one of the cars or a computer and at other times the buyer may be prepared to take over a finance lease on equipment. It’s whatever is agreed between them.
However it is a different story with the situations listed above. In these cases the valuation will have to include all assets and liabilities of the business, including debtors, creditors, bank loans and even contingent liabilities (debts that might happen in the future).
This makes it all the more important that you fully understand how the valuation process works and are fully involved.