As a business owner approaches retirement age it’s time start thinking about succession and estate planning, the first step is often valuing the family business.
Changes to the tax code require people doing valuations on certain assets to be a “qualified appraiser,” and the new fair value standards require valuation expertise to implement them.
Commercial Real Estate Appraisal: How a Family-Owned Business Valuation is Done
There are three primary business valuation approaches used in valuing an operating company. Under each approach, there are several valuation methods that can be used to estimate value.
Using the asset approach, adjustments are made to convert the assets and liabilities of the business from book value to estimated fair market value.
The fair market value of the equity considers the value of individual assets fewer liabilities, but does not consider the intangible value of your company, or its goodwill.
The asset approach generally establishes the floor value of an operating company.
In using an income approach, the company’s historical income statements are analyzed to determine if adjustments are needed to reflect your anticipated future operating results.
Normalizing adjustments are often made related to the following types of income and expenses:
- Removing unusual income or expense items
- Adjusting compensation to market levels
- Adjusting related party transactions to market levels
- Removing the impact of non-operating income or liabilities
Forecasts or budgets of future operating results are also considered.
The goal is to arrive at your expected annual future earnings while considering anticipated growth.
A discount rate or capitalization rate is developed based on what a hypothetical investor would require to invest in your company.
The value is then calculated by dividing the expected future earnings stream by the required rate of return. This approach considers both the tangible and intangible value of your company.
The market approach uses actual transaction data from similar businesses that have been sold.
This is accomplished by a comparison to publicly traded guideline companies or to actual transactions of similar privately held companies.
It may also include an analysis of actual prior transactions within the company being valued, if any.
The valuation analyst will typically use several methods to calculate the company’s value.
Using a reconciliation process to determine the final value, the analyst will select the method that is most suitable based on the valuator’s experience and expertise while considering economic, industry and company-specific factors.
The final step is to apply any required premiums or discounts to the value.
Depending on the interest being valued and the method utilized, the following are some of the most common premiums and discounts:
- Control premium
- Lack of control/minority interest discount
- Discount for lack of marketability
A properly prepared business valuation is a tool you can use for strategic and transition planning. Each business has unique characteristics that contribute to its value.
If you have interest in having a business valuation performed you can contact Real Estate Matrix at (877) 453-0221 or click here to fill out our form and we will get back in touch with you as soon as we can.