Ownership of a business or an interest in a business is generally one of the most valuable assets a person owns. Not only is this true from a financial standpoint, but it is often the culmination of hard work and ingenuity, wise investment, or it may represent your family’s legacy.
When it comes to a divorce or planning your estate, putting a value on a business is a big deal. Getting to this value is no simple task, as there are a plethora of business types, which in turn leads to numerous valuation methods. For your reference, here are some of the accepted approaches and factors that are considered by professional practitioners when determining the value of a business.
Accepted Approaches to Business Valuations
- Income approach. The income approach looks at the income and earnings of a business, the goodwill of the company, and potential to expand future earnings. This method can be effective for businesses that primarily deal in goods and services.
- Market approach. This approach creates an index of several comparable businesses in the same industry, looks at the earnings or assets of those companies in comparison, and also considers the goodwill of the companies.
- Asset approach. The asset approach values a business by calculating the difference between its assets and liabilities, while accounting for depreciation. This is most effective for companies that are asset heavy, such as oil corporations and real estate holding corporations.
Department of Treasury
In addition, the Department of Treasury has codified regulations to guide an appraisal of fair market value of a decedent’s interest in a business, for estate planning purposes. These factors include:
(a) A fair appraisal as of the applicable valuation date of all the assets of the business, tangible and intangible, including good will;
(b) The demonstrated earning capacity of the business; and
(c) Factors relating to the valuation of corporate stock, as specified in the Treasury Regulations.
The IRS Factors for Business Appraisal of Closely Held Corporations
For estate tax purposes, the IRS has provided guidance as to appraising closely held corporations or corporations for whom stock market quotations are unavailable or scarce. The IRS recommends careful analysis of the factors in this non-exhaustive list:
(a) The nature of the business and the history of the enterprise from its inception.
(b) The economic outlook in general and the condition and outlook of the specific industry in particular.
(c) The book value of the stock and the financial condition of the business.
(d) The earning capacity of the company.
(e) The dividend-paying capacity.
(f) Whether or not the enterprise has goodwill or other intangible value.
(g) Sales of the stock and the size of the block of stock to be valued.
(h) The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.
In addition, the IRS directs appraisers to prioritize earnings when valuing corporations that deal in goods and services, while focusing on assets for companies that deal in holdings and real estate.
Contact a Tax Attorney to Plan Your Estate
Business valuations are incredibly complex, but so critically important. You need a law firm who will help you get it right, and guide you toward a valuation that can withstand scrutiny from the court or from the IRS. Contact the Law Office of Robert S. Thomas. I have over twenty years of experience in the areas of estate planning, probate, IRS taxation, and family law. Contact our offices today at 847-392-5893 to schedule a consultation or visit our website today.