When valuing a business, experts often look beyond the company’s financial statements. Management interviews and document requests may provide additional objective insight into how much the owners believe the business is worth. This information shouldn’t be used as a substitute for a comprehensive valuation analysis, but it may identify discrepancies that need to be reconciled. Here are five common alternative indicators of value that experts may consider:
1. Buy-sell agreements. Owners often protect their business interests with buy-sell agreements. These agreements may provide a specific value for the business or contain valuation formulas to be used on an owner’s death or termination. Some detailed buy-sell agreements may even specify whether valuation discounts apply and, if so, how much. But if a buy-sell agreement has been superseded or is otherwise outdated, it may not be as relevant to current market values.
2. Prior sales. Arm’s-length transfers of ownership interests and offers to buy the company (or a portion of it) can shed light on a company’s value. Courts tend to give significant weight to prior sales and offers, especially when evaluating fair value for dissenting or oppressed shareholder claims. In some cases, courts may even consider transactions that happen after the valuation date. For data to be meaningful, the transaction should occur within a reasonable time frame; involve unrelated, credible buyers; and include business interests of comparable size and rights.
3. Past valuation reports. Valuation reports prepared for other purposes can provide insight into a company’s value. Again, comparability and timeliness are imperative. For instance, a gift tax valuation prepared when a shareholder conveyed a minority interest to his or her daughter may not be relevant when estimating the fair value of a dissenting shareholder’s interest in the same company.
4. Life insurance policies. Life insurance coverage can provide a useful indicator of value. When selecting adequate life insurance coverage amounts, most companies estimate the costs of buying out the owner and of losing a key individual. To the extent that coverage was arbitrarily selected or chosen under dissimilar business conditions, however, it should be viewed with caution.
5. Personal loan applications. Personal loan applications may be subpoenaed to provide evidence of a business interest’s value for owner disputes and marital dissolutions. When borrowers list personal assets on loan applications, they want to appear as creditworthy as possible. Conversely, when buying out another shareholder or obtaining a divorce, owners have a financial incentive to undervalue their business interests. When the amounts shown on loan applications and valuation reports differ substantially, it may raise questions.
Transparency is key
Most valuation reports address these indicators of value, but they’re sometimes overlooked or unavailable — or withheld by the valuator’s client. It’s important to share all relevant information with your valuation professional. Contact us to discuss how alternative indicators of value may be used to corroborate (or refute) a value conclusion.
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