What is Your Business Worth?

What is your business worth? Or, what is any business worth? The short answer is that it is worth what someone would pay for it if the owner decides to sell. But that answer is not very helpful in most circumstances where the question arises.

There are many reasons we want to know what a business is worth. If there are multiple owners, they may want to establish a buy-sell agreement that will define the price and terms if one owner dies or voluntarily leaves the business. In that instance, a value must be set or, at least, a formula for determining value must be agreed upon. For estate planning purposes, it is important to understand the value of the business so estate taxes can be anticipated and hopefully minimized. A bank or other commercial lender may require some value information as part of a financing transaction. Whenever new shareholders or partners are brought into a business, we must set a value on the interest they will purchase or earn. If the owner is contemplating retirement or a sale for any reason, value is the major issue in any transaction. And even if there is no requirement to value a business, many owners are curious and want to know.

When any of these situations becomes contested or confrontational, there is always the possibility that the value of an enterprise becomes an issue in court.

Value Defined

Depending on the reason for the valuation, Wisconsin has two different definitions of value: “Fair Market Value” and “Fair Value.” They sound similar and they are very similar but there are subtle but important differences. Fair market value is typically defined as the hypothetical price at which the business would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of relevant facts.

The similar concept of fair value is applicable to define the value for shareholders that dissent from some major corporate action and become entitled under the law to receive the fair value of their shares. The process for determining fair value is very similar to the process for determining fair market value but some of the adjustments typical in a fair market value appraisal are not applicable in a fair value appraisal. The most typical differences are that fair value appraisals do not reduce value for minority interests or lack of marketability.

How do business appraisers determine this hypothetical fair market value for a business enterprise? The first task of a business appraiser is to determine what is to be valued. Is it a business? A Mary Kay distributor or a sole practicing lawyer probably has a job, not a business. They may not be able to sell what they have as a business. If they have assets, real estate, vehicles, office equipment, they could sell them but they probably do not have a business to sell.

Occasionally, there are rules of thumb that are generally accepted in a particular industry. An example might be that a sawmill is valued as a multiple of the number of board feet of lumber it can produce in a year. Or a beer distributorship may be valued based upon volume sold. Those are not real world examples but are offered to explain the rule of thumb concept. Even if there are rules of thumb, a full scale valuation is appropriate in most cases.

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