Missed part 1? You can read it here.
Understand Your Purpose Before You Make The Call
Imagine investing valuable time, money, and effort in a business appraisal only to find that your report contradicts your intended Purpose. You can alleviate this risk by understanding the role your purpose plays in business valuations. If you know this information before you make the call, you can ensure you receive the maximum value from your business valuation investment.
Business Valuation Purpose
Your Purpose determines your business valuation outcome. Shannon Pratt, a well-known authority on business valuation, explains it like this: “It comes as a surprise to many clients that there is not just a single value for a property but that there can be different values for the same property – even at the same time – depending on the definition of value being sought.” (Pratt, Shannon, Robert F. Reilly, and Robert P. Schweihs. Valuing Small Businesses & Professional Practices. New York: McGraw-Hill, 1998, p. 38).
In the previous blog post, the stage was set to explain how two different purposes could result in two different values for the same business. Recall in Appraise My Business (Part 1), you discovered two dominant reasons qualified business valuation specialists right now:
1. Current tax advantages for gift and estate planning
2. Baby Boomers seeking liquidity options
Purpose 1: Lowest Defensible Value Business
Believe it or not, you want to know the “lowest defensible” fair market value of your business if your purpose is for tax advantages. Why? Because of the lower value of the block of shares you gift, the lower the income and gift tax owed to the IRS. For this purpose, qualified appraisers use two arguments: “Lack of Marketability” and “Lack of Control” that, if applicable, justify “discounts” to the fair market value, thus providing the lowest defensible value.
Purpose 2: Full Fair Market Value Business
Alternatively, a baby boomer evaluating future liquidity options wants to know the full fair market value of their stock. This should also be defensible, and that requires a thorough examination of all the factors specific to your business case. IRS Rev. Rul. 59-60, a widely referenced guideline for determining Fair Market Value, states that: “A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will generally apply to the multitude of different valuation issues…” (Pratt, Shannon, Robert F. Reilly, and Robert P. Schweihs. Valuing Small Businesses & Professional Practices. New York: McGraw-Hill, 1998, p. 866.)
Indeed, this discussion only scratches the surface on Purpose and your intended Fair Market Value.
Nevertheless, you are now equipped with two valid discussion points when you call. It is a good idea to review a qualified appraiser’s Professional Standards for added call preparation. Accordingly, they will spend ample time with you discussing your purpose and the appropriate approaches. Whereas, if the person taking your call is not confident in explaining terms such as “lowest defensible value” and “valuation discounts,” or in describing and providing written Professional Standards, you now at least know enough to call someone else.
Comments: If you see similar or additional trends, please share your comments.