- December 30, 2016
- Posted by: admin
- Category: Buying a Business, Competitive research
The “fair market value” of your company is supposed to be an objective valuation technique that exists mostly in a bubble outside of any pending sale negotiations. As IRS Revenue Ruling 59-60 states, the fair market value of a business should be the “price at which property would change hands between a willing buyer and a willing seller, each having reasonable knowledge of the relevant facts and neither being under any compulsion to buy or sell.”
While this hypothetical scenario leaves many open-ended questions, business owners should consider a fair market valuation a more neutral, objective price than what would arise during negotiations between buyer and seller.
Determining fair market value of your company can help set benchmarks for your future listing or closing price. It can also have a significant impact on other financial aspects for both the owner and the company itself. For instance, a business’s fair market value can come into play when someone with an owner stake wants to engage in estate planning and wishes to know how their holdings can affect inheritance and tax laws.
The nature of fair market valuations can be complicated. Companies should rely on proven business strategy and valuation experts, who can assess the various factors and determine your strategy for business accounting, listing your business for sale and personal estate planning.
Consider the following information regarding fair market value assessment, and be sure to follow up with a valuation consultant in Henderson, Nevada before committing to any decisions.
Determining Fair Market Value with Common-Sized Statements
The first step for most businesses assessing their fair market value is to review the past five years’ tax returns. You should then weight the value of accounts and assets per their respective percentages of the total.
Starting from the date on which you wish your fair market value to be assessed, obtain the past five years’ worth of tax return statements. Each item’s dollar value on income statements should be calculated as a percentage of total revenues, and each line item on the balance sheet should be calculated as a percentage of the business’s total assets. Each of these percentages are referred to as “common-sized statements.”
After these common-sized statements are obtained and necessary adjustments have been made, they can be processed using ratio analysis and attain an overall performance assessment for the company.
Determining Fair Market Value through Other Valuation Approaches
There are many other valuation techniques in addition to ratio analysis that a business valuation consultant can use to get different perspectives on your company. One is an income approach, where your earnings history is examined to project future earnings potential. The other is a market-based approach, where market transaction similar to your planned (or hypothetical) business sale are considered relative to current market conditions.
Some companies may also use a cost approach if their assets exceed their typical income, as may be the case with real estate holding companies.
Any valuations obtained through various methods are typically weighted based on the company’s strengths and current conditions and then averaged together. This final number represents the “fair market value” of your company. It can be used to assess the objective value of ownership stakes when they engage in estate planning. It can also affect other aspects like an agreed-upon share price for buy-sell purposes.
Why Your Business’s Fair Market Value May Differ from Sale Price
Business sales have a lot more variables than the objective value of a company. Perhaps the buyer is doing the seller a favor like letting them retain a certain trademark, so the final price of the business reflects the perceived value of the favor subtracted from the sales price. The buyer may also be highly motivated, encouraging them to purchase above the fair market value.
These differences can have financial effects for the business or its owners. For instance, when a business owner transfers their stake to someone else below the fair market value, the difference between the final price and the fair market value may be considered a “gift” under tax law.
Because of the complex nature of valuations and business sales in general, business owners should act prudently by consulting with a business valuation and strategy expert, who can help them obtain the information they need and advise them on strategies that can provide the most benefit.
You can contact Jamie Schwartz of Schwartz Strategy and Valuation to begin the process of valuation or selling or to find out more about how they work. Contact us today!