4Thought Blog

Most business owners and attorneys know the basics of the business valuation process.

For example, you might know that there are three approaches to value: the cost, market and income approaches. You might even know some of the methods that fall under these approaches, including the:

• Adjusted book value,
• Excess earnings,
• Guideline public company,
• Merger and acquisition,
• Capitalization of earnings, and
• Discounted cash flow methods.

But experienced laypeople also understand that the process of valuing a business is not simply a matter of plugging numbers into these "black boxes" and having the answer spit out the other end. Instead, the valuation analyst uses professional judgment to arrive at a reasonable conclusion of value.

If you own a business, you're probably familiar with the protections provided by buy-sell agreements. But do you know how important these documents can be to an estate plan?

Because buy-sell agreements specify whether, and under what circumstances, owners' interests may be transferred, they can help you control the ultimate disposition of your business and achieve other important estate and succession planning goals.

When a business is owned by more than one person, it's generally advisable for the owners to enter into a contractual agreement that prescribes what will happen if an owner dies, becomes disabled, retires or otherwise leaves the company.

Some market analysts predict that the COVID-19 crisis may trigger an increase in buyouts. For example, some struggling owners may decide to throw in the towel after months of teetering on the verge of bankruptcy. Or squabbling partners may disagree about the future of the business and decide to part ways.

So, now is a good time for owners to draft or update a buy-sell agreement. Here's a look at common valuation issues and potential pitfalls to avoid.

Business valuation is a prophecy of the future. That is, investors typically value a business based on its ability to generate future cash flow.

However, with so many uncertainties in the current marketplace, forecasting expected cash flow can be challenging.

In today's environment, it's important for business owners to focus on the value of their company and what drives it. The objective of this article is to look at value drivers for operating businesses, as opposed to businesses that are asset-based, such as real estate or securities holding companies.

Under the market and income approaches, operating businesses are valued based on how much cash flow they're expected to generate in the future. In other words, cash flow drives value.

If you want to increase value, you need to increase sustainable cash flow.  Notice, we said the sustainable cash flow. While it might look good to have a short-term increase, an educated buyer will see through any non-sustainable increases and adjust those in determining the purchase price.

While preparing your succession or estate plan, it can be helpful to value your family business both internally and externally.

You might wonder what that means — because you think your company has just one value. In fact, it can have multiple values depending on the valuation standard used. The different results can help you determine whether to keep the family business, pass it on to the next generation or sell it to an outsider.

Two common standards used in valuing a family business are:

Many businesses will pay less federal income taxes in 2018 and beyond, thanks to the Tax Cuts and Jobs Act. And some will spend their tax savings on merging with or acquiring another business.

Before you jump on the M&A bandwagon, it's important to understand how your transaction will be taxed under current tax law.

Let's say divorcing spouses own part of the stock in a closely-held corporation. This may be one of their biggest marital assets, and often one spouse decides to buy out the other party's shares by transferring some assets in exchange for the stock. Before jumping headfirst into these transfers, it's important to consider the expected tax consequences.

What is the value of my business? That's the question every business owner wonders from time to time. But the correct answer varies depending on the purpose of the appraisal. Different rules and "standards of value" may apply in different circumstances.

There are a number of reasons you might want to determine the value of a business, including:

• Business planning,
• Potential sale or purchase of a business,
• Gift, estate and other tax purposes,
• Buy-sell agreements,
• Business litigation, including shareholder disputes and oppression cases,
• Marital dissolutions, and
• Financial reporting.

Here's a closer look at some of the common reasons to value your business.

When it comes to business valuations, not all valuation reports are created equal.

In fact, the professional standards for both the American Institute of Certified Public Accountants and National Association Of Certified Valuation Analysts specify two distinct types of valuation engagements: a calculation engagement and a valuation engagement.

While the reports produced by both engagements share many common characteristics, it is important for business owners to understand the key differences and appropriate uses with each engagement.