Reprinted with permission from www.carlson-advisors.com
Most business owners spend a lifetime building their businesses, and when it comes to succession, they face the difficult decision of whether to sell, dissolve or transfer the business to family members or a nonfamily successor.
Many complicated issues are involved, including how to divvy up business interests, allocate value and tackle complex tax issues. Thus, as you put together your succession plan, include not only your financial and legal advisors but also a qualified valuation professional.
Various value factors
When drafting a succession plan, a valuation expert can help you put a number on various factors that will affect your company’s value. Just a few examples include the following:
Projected cash flows: According to both the market and income valuation approaches, future earnings determine value. To the extent that a business experiences decreasing or increasing demand and rising or falling prices, expected cash flows will be affected. Historical financial statements may require adjustments to reflect changes in future expectations.
Perceived risk: Greater risk results in higher discount rates (under the income approach) and lower pricing multiplies (under the market approach), which translates into lower values (and vice versa). When making comparisons, the transaction date is an important selection criteria a valuator considers.
Expected growth: Greater expected revenue growth contributes to value. In addition, there’s a high correlation between revenue growth and earnings (and, thus, cash flow) growth.
Other determinants of discounts
In many cases, valuation discounts are applied to a company’s value. For example, decreased liquidity translates into higher marketability discounts, while increased liquidity reduces marketability discounts. Other factors that affect the magnitude of valuation discounts include the following:
- Type of assets held
- Financial performance of the underlying assets
- Portfolio diversification
- Leverage
- Owner rights and restrictions
- Distribution history
- Personal characteristics of the general partners or managing members
Discounts vary significantly but can reach (or exceed) 40 percent of the entity’s net asset value, depending on the specifics of the situation.
For best results
An accurate and timely value estimate can facilitate the succession process and prevent costly and time-consuming conflicts.
Carlson Advisors is a CPA and business consulting firm with offices in Minneapolis and St. Cloud, Minnesota. With nearly 40 years of experience working for clients nationwide, Carlson Advisors offers a team of seasoned advocates ready to help you identify and maximize every business opportunity. For more information, contact valuation specialist Dawn Polfliet, CPA/ABV at Carlson Advisors, LLP, 763.535.8150 or dpolflieta@carlson-advisors.com.