Looking beyond the financials for clues to a business’s value
An experienced business valuation professional considers more than just a company’s financial statements when quantifying its value. The professional conducts detailed interviews and asks for a variety of documents when gathering information to use to value the business — and some of this information may provide objective insight into how much the owners believe the business is worth. Here are some key examples.
Shareholders often protect their business interests with buy-sell agreements that contain valuation formulas to be used on a shareholder’s death or termination. Some detailed buy-sell agreements may even specify whether valuation discounts apply and, if so, how much. But if a buy-sell agreement has been superseded or is otherwise outdated, it may not be as relevant to current market values.
Life insurance policies
Life insurance coverage can provide another useful value indicator. When selecting adequate life insurance coverage amounts, most companies estimate the costs of buying out the shareholder and of losing a key individual. To the extent that coverage was arbitrarily selected or chosen under dissimilar business conditions, however, it should be viewed with caution.
Personal loan applications
In shareholder disputes and marital dissolutions, personal loan applications can be subpoenaed to provide evidence of a business interest’s value. When borrowers list personal assets on loan applications, they want to appear as creditworthy as possible.
Conversely, when buying out another shareholder or obtaining a divorce, shareholders have an incentive to undervalue their business interests. When the amounts shown on loan applications and valuation reports differ substantially, it should raise questions.
Arm’s-length prior stock transactions and offers to buy the company (or a portion of it) can shed light on a company’s value. Courts are especially fond of relying on prior transaction data. For these items to be useful, they should occur within a reasonable time frame and involve unrelated, credible buyers.
The size and rights of the business interests also should be comparable. For example, the 2002 sale of a 1% nonvoting interest probably wouldn’t provide an especially meaningful indicator of the current value of a 99% voting interest in the same company today. For offers that never materialized, the reason the deal fell through may bear on its usefulness.
Also beware of strategic buyers that offer substantial premiums for buyer-specific synergies — their offers may not truly be indicative of fair market value, if that’s the standard under which the current value is to be determined.
Past valuation reports
Valuation reports prepared for other purposes can provide insight into a company’s value. Again, comparability and timeliness are imperative. For instance, a gift tax valuation prepared when a shareholder conveyed a minority interest to her son may not be relevant when estimating the fair value of an oppressed shareholder’s interest in the same company.
Full disclosure is critical
Most valuation reports address these indicators of value, but they’re sometimes overlooked, unavailable — or withheld by the valuator’s client. It’s important to share all relevant information with your valuation professional. Contact us to discuss how lesser-known indicators of value may be used to corroborate (or refute) a value conclusion.