September 06, 2006

$ & Sense

Individual investors are used to keeping a close eye on the value of their portfolios. But as a small-business owner are you also keeping careful watch over the value of what is probably your biggest investment — your business?

Although you may regularly monitor sales and profit figures, doing so without knowing how much your business is worth in today's market is comparable to looking only at your portfolio's earnings without knowing its overall worth. Just as investment decisions should be geared toward maximizing the value of your portfolio, the same criteria should apply to decisions that affect your small business.

Most small-business owners realize the importance of knowing their companies' worth during major transitional periods such as mergers and acquisitions, shareholder buyouts and initial public offerings. However, every major business decision you make has the potential to affect the value of your company. Have you ever thought about relocating to more-modern facilities, upgrading your technology, expanding your product line or changing your management team? If so, knowing the current value of your business will help you predict more accurately what the impact of such actions is likely to be.

When asked, small-business owners regularly overvalue or underestimate the worth of their companies by as much as 50 percent — which is understandable, given the complexity of the valuation process. Although no one formula can realistically estimate the value of your business, there are some basic variables that can be applied in most situations. These include current market conditions and the company's stock value, earnings history, financial condition and future earnings capacity.

However, these basic components may not be as simple as they appear, since they deal with numerous complicated factors, such as supply and distribution contracts, tangible and intangible assets, and pending legal and regulatory issues, among others.

Professional valuation firms — some of which specialize in serving small-to-medium-sized businesses — have the resources and experience to collect and interpret this essential information.

Different types of business valuations feature different levels of complexity. As a small-business owner, the type that's best for you will probably depend on why you're having the valuation prepared. If you're preparing a valuation for tax and estate-planning purposes, a "59–60" appraisal may be your best choice. Based on IRS Revenue Ruling 59–60 (the IRS standard for estate and gift tax purposes), a 59–60 valuation compares a privately held company to public companies in the same or a similar line of business and then applies a lack of marketability discount or a control premium.

If, however, you're preparing a valuation for a specific purpose such as a sale, merger or acquisition, you'll probably need a more detailed appraisal tailored specifically for the specified purpose. In general, transactional appraisals will require more time and money than 59–60 valuations, because of the additional factors such as products, management and competitors to be examined.

Regardless of which type of valuation you need, it should be updated on a regular basis. If you review your business plan once a year, consider updating your business valuation at that time. Doing so will help you evaluate the effectiveness of last year's business decisions and may even offer some insight into the year ahead. And remember, your business decisions — like the decisions that affect your portfolio — should always be geared toward maximizing the value of your investment. Although it is frequently overlooked, current valuation is an extremely useful tool for the small- and medium-sized business owner.

Michael Pellman

Retirement Planning Specialist

Morgan Stanley- Riverhead



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