As 2020 draws to a close, many business owners are determining what tasks they’d like to accomplish in 2021. Many of these tasks involve creating value. Knowing where you are starting and why leads to better decision making. Adams Capital’s business valuation services help owners navigate these situations.
Let's highlight some questions facing business owners at year-end. As a valuation firm that has provided more than 3,000 valuations over our 24 years in business, we have the experience to anticipate and prepare for contingencies that owners might not foresee.
We hope this article will provide some helpful guidance as you make decisions for the future success of your business.
How do I divide my business fairly?
In a recent phone consultation, we had a conversation with a highly successful business owner who is contemplating how to divide his business interests after he retires. He has one nephew who works at the business regularly and takes a large role in managing the day-to-day operations. He loves the work, and he is passionate about the success of the business. The owner also has two nieces. Both have small roles in the business, and they aren’t interested in taking on larger roles.
The uncle wanted to split up the business evenly between the three siblings and asked for our guidance. After gathering the facts, we told him that his current plan was risky. By giving each one an equal share in the business, the uncle would unintentionally be making the nephew a minority owner. What if the two nieces wanted to sell? There would be nothing the nephew could do.
To resolve this situation, we recommended that he consider ensuring that all three had an equal economic windfall from the business, but not an equal ownership stake. He agreed this was preferable for him and for his nieces and nephew. We helped him structure his will so that the nephew maintained ownership and the nieces were able to get leasing income from real estate holdings.
Should I get a third-party appraisal when I’m being bought out, even if my family doesn’t want one?
Another phone consultation occurred with a member of a family business who had asked to be bought out. He was no longer interested in being part of the company, and he wanted his transition out to be fair and as smooth as possible for everyone involved.
When he approached the family, they said that his share was worth a few million dollars, and made the offer for the buyout. When he suggested a third-party evaluation to verify the buyout amount, the family members claimed it wasn’t necessary and it would only represent an additional expense.
With millions at stake, why bow to family pressure? We encouraged him to get an evaluation. One of the greatest benefits of third-party evaluations is that they are independent. The business valuation process provides an outside perspective that uses objective data, pre-defined processes, and specialized expertise to determine the value of a business, accurately and without bias. By skipping an evaluation, this family member could be leaving millions of dollars on the table, leading to strained family relationships down the line. Wouldn't you want the same standards that are required by fiduciaries if they were making such decisions on your behalf?
My accountant said I should call you and talk about discounts. What are discounts and how do they impact me?
Discounts correct for imbalances. They are often applied by appraisers to ensure an accurate assessment of the value of an asset or a business. For example, business valuation professionals will apply a minority interest discount for a minority ownership stake in a company. This is because minority stakeholders have less control over the business. They cannot sell the company, declare or pay dividends, or make acquisitions. This lack of control means that a 1% controlling interest has greater value than a 1% non-controlling interest in the same company.
Another common discount is a marketability discount. This discount reflects the difficulty of selling an asset, like a piece of real estate or the share of a business. Fundamentally, a marketability discount is related to greater lengths of time and higher costs required to sell a particular asset. The traditional definition of marketability is that an asset can be sold and the seller receives cash within three business days. If a longer amount of time or additional costs are required to sell an asset, it is considered non-marketable.
Discounts will impact the price of an ownership stake in a business. This price has tax implications for individuals who are buying, selling, or gifting their ownership stake. Getting a well-documented third-party business valuation can be an important part of your wealth management and tax strategies.
I’ve promised someone stock or financial compensation in the event of a sale. Do I need to put it in writing?
Yes. Written agreements are vital to protect individuals and businesses. Many owners spend their entire lives building successful businesses, saving aggressively, and sacrificing to ensure the success of their company. They can lose everything in the blink of an eye if they don’t plan for the future.
If an owner becomes sick or dies, no one will be able to execute their wishes without written agreements. In some cases, other business owners might not even know of these off-the-books equity compensation agreements. In that case, the person who was promised the compensation might try to approach the grieving family, asking for what they were promised. This can cause distress for family members, and the situation is unlikely to have a positive resolution.
We often see a similar scenario with disaster recovery plans. Owners spend time creating robust, well-reasoned disaster recovery plans, but they don't’ write them down or tell others in their company. This poor communication can produce disastrous results.
I own 100% of my business. Why do I need a buy/sell agreement?
Business owners should plan for contingencies to ensure that their business is able to succeed even in difficult circumstances. Most owners have provisions in their will that leave their businesses to multiple people. Put a mechanism in place where some members of that group can buy out others while keeping the company running smoothly. A written buy/sell agreement will make this process much easier for the new owners, and it increases the long-term health of the business.
Conclusion
Third-party valuation firms can help business owners prepare for unexpected events that could negatively impact the business and cause distress to family and friends without proper planning. Adams Capital specializes in helping business owners and legal counsel structure agreements and valuations in such a way that they can stand up to unexpected contingencies. We anticipate potential pitfalls and ensure that businesses can continue successfully even in difficult circumstances.
Adams Capital offers a no-cost initial telephone consultation to provide a sounding board to business owners who want to protect their businesses and plan for the future.
Please email us at tara@adamscapital.com or call us directly at 770-432-0308 to schedule a consultation or to learn more.
Author
David Adams is the President of Adams Capital, LLC. He is an expert in the valuation of businesses, business interests, and tangible and intangible property for mergers and acquisitions, corporate recapitalization, privatization, gift and estate tax planning, bankruptcy proceedings, dissenting shareholders, Employee Stock Ownership Plans, and financial and tax reporting. Frequently counseling business owners and families on methodologies to enhance shareholder value.