the value of your Business:
is generally no active marketplace for most small privately
held businesses it is often very difficult to determine
an accurate price for a business on any given day and
even harder to do it years in advance of a sale or buy
out. Nevertheless, it is a very necessary task in order
to prepare a sound buy-sell agreement. If the owners
of a business neglect to do this, they will be left
in a position to argue or disagree over price each time
an owner’s interest is bought by the company or
the continuing owners of the business.
things even further, should the owners find themselves
being forced to determine a price at the time of a death
or divorce of one of the other owners, negotiations
are sure to be burdened by the emotions of the owners
spouse, inheritors, or estate representative. Without
a pre determined formula for price in advance, the emotions
of a divorce situation could easily lead to a law suit
over price, and an untimely death could lead to the
deceased owner’s spouse being forced to take a
low ball price for the deceased owner’s shares
or even lead to an expensive law suit over price.
be hard to overestimate the importance of including
in your buy-sell agreement a price for the business
or a formula (also called a valuation method) that will
determine the fair price at the time of buyout.
1: Agreeing on a fixed price in advance
The simplest method is for all parties to agree on a
fixed price in advance. By setting a fixed price an
appraisal is not needed and it also makes it easy for
estate planning purposes and for funding the buy-sell
through death or disability insurance, since you will
know exactly how much coverage each owner will need.
2: Book Value Method
At the death of one of the owners, the value of many
businesses decline. Often times in this scenario, the
business becomes worth its book value or its assets
minus it liabilities. Typically this method uses the
most recent year end balance sheet to determine this
price. (This method generally works best for start up
companies and marginally profitable companies.)
3: Multiple of Book Value
This method calculates the value of the business by
taking the net assets or owners equity from your balance
sheet and applies a multiplier which the owners will
predetermine to set the price. This multiplier is used
to account for such things that successful businesses
have put in place to operate profitably. (things such
as securing a building to operate, training employees,
purchased inventory, marketing programs, establishing
an accounting system, client lists, goodwill, and other
4: Capitalization of Earnings
This method determines the value of the business by
its profits. Under this method you first calculate the
company’s annual earnings by taking gross revenue
minus the costs to do business. Next you multiply the
annual earnings by a number or multiplier. The multiplier
is usually reflective of the business or industry that
your business is in. Because the earnings of most businesses
move up and down, the prudent rule here is to use at
least 3-5 years of earnings history for this method.
5: Appraisal Value
This method simply involves all parties agreeing to
hire one or more professional appraisers to determine
the fair value of the business at the time of buyout.
In this method the remaining owners and the departing
owners each hire an appraiser to determine the value
of the company. If the appraisers each come up with
the same price, then often the parties can quickly settle
on a price. If the appraisers come up with vastly different
values, then the buy-sell agreement should require the
2 appraisers to choose a third appraiser to do another
valuation which will then be the binding price.
A good strategy
here is to choose the appraiser(s) in advance that all
parties are comfortable with.
of this method are it can be expensive and time consuming.
It also creates a scenario where the owner that is contemplating
leaving the business will not have the information they
need until a lot of costs and potential aggravation
have occurred. It also makes it hard to determine how
much coverage each party will need for the life insurance
or disability insurance funding portion of the agreement.
Most businesses and their situations are uniquely different
from one another. It may be determined that another
valuation method is more appropriate for your business.
This would be an area to speak with your accountant,
tax or legal professional to get a better understanding
of how they would go about valuing your business.