Knowing the appropriate time to perform a valuation is not always clear. Often considered both an art and a science, they are primarily used to determine the value of specific interest in a company.
When completed properly, valuations can provide meaningful insights that enhance decision making for strategic and tax purposes. Discussed below are three scenarios in which completing a valuation may be necessary or beneficial.
1. Estate and Gift Tax Planning
Valuation is often a critical component of proper estate and gift tax planning. The estate tax is calculated based on the FMV (fair market value) of the estate’s assets at the time of the decedent’s death. A valuation is often necessary to determine the FMV of closely held securities or business interests left by the decedent.
Estates are at a significantly higher risk of an IRS audit than the standard individual tax return. Therefore, it is imperative that estate executors follow the proper protocol when completing Form 706. If closely held securities are part of an estate, proper protocols will often include completing an independent valuation.
Meanwhile, effective gift tax planning should coincide with estate planning. Gifts that exceed the annual exclusion amount, which in 2018 is $15,000 transferred to one individual, must be reported on Form 709 and are also reported on a decedent’s estate return, thus contributing to the gross estate value. Gifting interest in closely held businesses, which in most cases exceeds the annual exclusion amount, is common practice that often requires a valuation. When completing estate and gift tax planning individuals/executors should always be sure to connect with the appropriate legal, tax and valuation professionals.
2. Strategic Business Planning
Business valuation is commonly misinterpreted as being solely for exit strategy purposes. While this is a popular use of the practice, it is also extremely beneficial for small businesses to conduct periodic valuations to supplement strategic decision making and growth.
In addition to exit strategies, such as selling a business or buying out fellow partners, valuations can be used to evaluate mergers and acquisition activity, understand the value of assets, determine how certain growth will affect a business’s value and add shareholders.
Small business owners and executive decision makers should note that a detailed business valuation report by an independent third-party valuation analyst is not always required for the aforementioned scenarios. Calculation engagements allow an analyst and client to agree on a valuation approach. This dramatically reduces the time and costs necessary to completing a proper valuation.
Furthermore, harnessing the power of business valuation in a recurring manner will provide owners and executives with a better understanding of how certain circumstances, from economic events to company specific expense activity, affect a company’s ending value. This, of course, will improve decision making regarding the optimal time to enter or exit a market and grow a business.
3. Marital Dissolution
When divorce occurs, there may be business or professional interest at stake. Prior to allocating interest to each party, it is important to determine an appropriate value of the underlying assets (both fixed and non-fixed) and liabilities.
Similar to estate and gift tax planning, some of these interests may be in closely held securities/small businesses. Prior case law and state statutes play a vital role in computing the value of closely held securities for marital dissolution. For instance, in some states, such as Massachusetts, certain discounts traditionally taken in small business valuation may not apply.
Furthermore, each state’s definition of the standard of value, which is a vital component of professional valuation, may differ. Should you ever require a valuation for marital dissolution and have interest in closely held securities, be sure to contact the legal, tax and valuation professionals with experience in your jurisdiction.
Estate and gift tax planning, strategic business planning and marital dissolution are only a few of the scenarios where an independent valuation may be necessary or beneficial. Other times when a valuation may be required include employee stock ownership plans (ESOPS), key person insurance and litigation support.
Regardless of the circumstances, contacting trusted legal, tax and valuation professionals will assist you in completing the necessary steps to valuing your business interest.
About Matt Paul
Matt Paul, CVA, MBA is a Senior Associate at Samet & Company, a full-services CPA firm where he focuses on valuation, tax, and financial consulting.