Author: Mary Honan

The Window of Opportunity is Closing

Many trusted advisors, including wealth managers, financial planners, accountants, and estate attorneys, refer their clients to Merrimack Business Appraisers to prepare a business valuation as part of a broader plan to transfer wealth and manage tax liabilities. We continue to see increased activity in transferring shares through gifting and selling shares of a business.

As a business owner, you may be considering transferring shares by gift or sale in advance of year-end or as part of a longer-term strategy to take advantage of the generous federal estate exclusions scheduled to sunset at the end of 2025. Transferring wealth can take many forms including gifting shares to family, employees, or an outside party. Your trusted advisors can assist you in determining if you are transferring 100% or fractional amounts, the length of time (e.g., 20% over 5 years) to implement your strategy as well as if a trust will be the vehicle used with beneficiaries defined.

The Benefits of a Qualified Business Appraisal

Transferring shares of your business is an integral part of estate planning and strategic planning including succession planning. Your goals may be implementing your succession plan or implementing your estate plan. Whatever the motivation, it is important to understand the benefits of having a qualified appraisal prepared by a qualified appraiser. That is the criteria the IRS uses to substantiate the value of the shares.

When gifting shares of your business, you should have a business valuation prepared to determine the value of the business and the associated shares. Whether you are gifting shares to a long-time valued employee or a family member, the IRS may take interest in evaluating if the valuation was too low. Think of the business valuation as the supporting documentation for filing a gift tax return. You are required to file a gift tax return when transferring ownership interests in a business, and there are benefits to including a qualified appraisal by a qualified appraiser. Simply (we are talking about the IRS so it is a bit complicated), if you file a gift tax return with a qualified appraisal, the statute of limitations is shorter and the burden of proof of the valuation of the gift shifts from the taxpayer to the IRS. If you file a gift tax return without the supporting documentation of a qualified business valuation, the statute of limitations is longer and the IRS can challenge the valuation of the transfer of wealth and the burden of proof is on you, in this case the business owner who transferred the wealth. The risk is real.

With declines in the markets and many indicators of our economy entering a recession, now can be a wise time to transfer wealth based on lower business valuations.

If you are speaking to your advisors about transferring wealth via gifting or selling, contact Merrimack Business Appraisers so you have a qualified business appraisal developed by a qualified business appraiser.

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A Best Practice for Determining Business Valuations

Some thrived. Some closed. Some crashed early in the pandemic and now are making a comeback to pre-pandemic performance levels. One thing is certain: it has not been dull.

Since early 2020, we have seen tremendous variability in the financial markets and in business performance across industries. The pandemic has had a dramatic impact on where we work and how we work. Business models pivoted to offer touch-less service, online order placement and pick-up/take-out models. Businesses have soared and sunk. During these volatile two plus years, the same business may have experienced both; soaring and sinking. Peloton is such an example, early on in the pandemic their business soared; they were challenged to keep up with demand for bikes and treadmills; yet recently they have struggled. The business cycles have been extreme.

Today, more than two years after the start of the pandemic, inflation is high, interest rates have risen and recession indicators are many.

So, with all this volatility, how has valuation of a business been affected?

Business Valuation: The Drawbacks of Looking Back

Imagine business owners who have experienced peaks and valleys during the pandemic contemplating selling their business today? A ‘mechanical’ approach to business valuation based on an average of the past five years of earnings would be problematic for many businesses across many industries. The approach is fundamentally flawed and those flaws are exacerbated by the volatility of the past several years.

Be informed. As you speak to a business valuation expert, ask the method the professional adopts to prepare the valuation. If looking back is the view they take on valuation, I suggest you move forward.

A Best Practice: Look Forward

The Discounted Cash Flow Method is an income-based approach to valuation that is based upon the theory that the value of a business is equal to the present value of its projected future net benefits. This method understands that the past gives insight into the performance of the business, but the past does not dictate value. The fundamental difference in methods is the lens that is used: looking to the past vs. looking to the future.

The discounted cash flow method that I incorporate into the detailed business valuations prepared to withstand scrutiny look to the future to calculate the expected future economic benefits that will flow to the business owner, net of risks.

Starting with benefits: effectively applying this method requires that a business valuation professional understand and analyze the fundamentals of the business. This includes analyzing factors affecting demand, revenue, and profitability.

Today, many businesses are experiencing high demands for their products and/or services. Demand is up, revenue is up, but profitability is being squeezed due to rising costs of source materials, labor, and transportation costs due to rising gas prices. Early in the pandemic, we witnessed high demand for contractors, tradespeople, and appliances as home improvement projects surged. Today, costs are increasing at a rate that for most industries can’t be passed onto the consumer so while revenue may be up, profit margins are shrinking.

Then we look at the risks; many of which a business owner has little control over. Such macro risks include the effects of the war in Ukraine, inflation, high gas prices, and rising interest rates.

Risks specific or unique to the business include assessing the impact of the labor shortage on business operations, supply chain exposures, and a ‘hidden cost’ that is becoming more visible: the cost of the owner filling in as an employee; working ‘in’ the business vs. ‘on’ the business. For many businesses, this will have a negative effect on the long-term health of the business as strategic thinking is traded for near-term productivity. Such risks are noted and accounted for in the discounted cash flow method to calculating the net present value of future net benefits.

A Constant in the Chaos: The Discounted Cash Flow Method

Look forward. As a business owner, keep looking ahead and if you are considering selling, do not worry about the volatility of your business looking back over the past two years. The best method for valuation will look ahead, not back.

In the midst of chaos, certainty always appears elusive. Yet, for business valuation there is a constant. The best method to determine the value of a business is to calculate the net present value of future benefits.

If you have been referred to multiple business appraisers, ask what method they use to calculate valuation and inquire about their process and their track record. While complex in nature, the answers should be clear and understandable. When Values Matter, secure the expertise you and your business deserve. Contact us so the valuation of your business is not unnecessarily discounted.

Scenarios for Tax, Gift & Estate Planning

In my last blog, I shared that I thoroughly enjoy working on unique scenarios where a business valuation is needed. A business valuation is often part of a well-thought-out business plan to protect business interests and reduce tax liability.

This blog discusses three scenarios where residential properties need a ‘business’ valuation. Why would a business valuation be needed for a residential property? Below I highlight two common scenarios and one tax planning strategy that I am starting to see more frequently:

Scenario 1 – Income Producing Investment Property

Individuals purchase residential real estate as an investment and to produce income via renting the property, have the property held in an entity, commonly an LLC or a trust, as part of their tax planning strategy. Historically, many invest in residential real estate as an investment strategy, sometimes having fractional shares held in a trust with the children being the beneficiaries. In this scenario, a business valuation is needed to determine the business value (e.g., of the entity) to then calculate the value of each fractional share. The property is rented out via traditional real estate channels or leveraging such services as VRBO or Airbnb as examples.

Scenario 2 – Vacation Property

Throughout New England and across the globe, there are many vacation homes that have been owned by families for generations. Many of these homes are also income producing properties that may be owned by a family (with fractional shares) or a single party. When the family or single party owner chooses to have the income producing property held in a trust or LLC, a business valuation is need and if multiple owners, the value of each fractional share is determined.

Often the death of a shareholder will trigger the need to recalculate the value of the fractional shareholders; requiring a business valuation to be prepared first to then recalculate the value of each fractional share.

My previous blog explained the process for a business valuation that includes real estate and below is an overview of that process.

To explain this scenario, let’s assume at the time of death of one of the shareholders, there were five shareholders in the property. Over the years, the extended family includes grandchildren and it has been determined that grandchildren over the age of 25 are to be granted shares in the vacation property. The valuation of the entity is determined and then the value of the fractional shares is recalculated, to include the adult grandchildren as shareowners.

Scenario 3 – Primary Residence in an Entity

The above two scenarios have been common for years. An emerging estate tax planning strategy being implemented by high net worth individuals includes putting their primary residence into an entity. The entity typically includes other assets with the property leased back to the high net worth individuals who pay rent. A business valuation is prepared to determine the value of the entity, incorporating the real estate appraisal prepared by a real estate professional. The value of fractional shares are then determined by Merrimack Business Appraisers. While less common than the other two scenarios, we are seeing more business valuations where high net worth people are working with their professional advisors to protect wealth and pass assets to the next generation.

Overview of the Valuation Process for Income Producing Real Estate

It may seem odd to describe preparing a business valuation for residential real estate, but as income producing property, the residence has been put into an entity as part of a tax planning strategy.

The business valuation work we develop determines the value of the real estate entity and the fractional shares when the entity is initially formed, and again when there are changes to the number of shareholders. In both cases, a business valuation is needed.

My valuation work accounts for whether the property is income producing property with rental or lease income. To develop the business valuation of the real estate, I will leverage the real estate appraisal completed by a real estate professional. The balance sheet data will be updated to replace the original cost of the property with the current real estate appraisal; then I deduct any liabilities to determine the equity value. Based on the number of fractional share owners, I calculate the value of the fractional shares for the owners, which may go into trusts.

Conclusion

There are effective tax planning strategies to transfer wealth to the next generation. As you work with your professional advisors to plan and implement such strategies, keep in mind the need for a business valuation. A common misperception is you only need a real estate appraisal. With residential property held within a business entity, you need both a real estate appraisal and a business valuation expert to then calculate the total value and the fractional shares. Get the real estate appraisal completed and we can then take it from there.

Contact us to assist you in determining the value of the residential property and the fractional shares as part of implementing effective tax planning strategies.

When Values Matter

The Need for a Business Valuation to Value Fractional Shares

Business valuations are typically thought of in the event of selling a business, allocating assets as part of a divorce settlement, or settling an estate. What I thoroughly enjoy about what I do is the unique scenarios of how a business valuation can be part of a well-thought-out business plan to protect business interests and reduce estate tax liability.

An Overview of the Situation

A business entity owns real estate. The business and real estate are put into two separate entities, such as an LLC. This is typically done to protect the real estate interest from potential litigation. Next, for estate planning purposes, the real estate interest is divided into fractional shares for the owners. The overriding principle for this strategy is that fractional shares are worth less than the pro rata shares of the whole. A topic for a separate blog, perhaps.

The Role of a Business Valuation

Given the above situation, the business valuation work that I then do determines the value of the real estate entity and the fractional shares. My valuation work accounts for whether the property is income producing property with rental or lease income or if the property is used for the business. To develop the business valuation of the real estate, I will leverage the real estate appraisal completed by a real estate professional. The balance sheet data will be updated to replace the original cost of the property with the current real estate appraisal; then I deduct the liabilities to determine the equity value. Based on the number of fractional share owners, I calculate the value of the fractional shares for the owners, which may go into trusts.

When values matter for a business owner and there is real estate involved, get a certified business appraiser involved to help implement your estate planning strategies with fractional share ownership of the real estate entity. As noted above, you need both a real estate appraisal and a business valuation expert to properly implement this effective estate planning strategy.

Contact us when values matter.

When developing a thorough and detailed business valuation, conducting a site survey of the business is an important step in our proven process.

Don’t you need to be nearby to complete a site survey as part of a business valuation?

For many months during the pandemic, in-person site surveys were not possible as non-essential businesses were shut down or access was limited for the safety of the employees. In these situations, we completed the site survey virtually. The reality, however, is I have been conducting effective virtual site surveys for many years.

Assessing a Site Effectively

For decades, I have been preparing detailed, thorough business valuation reports to substantiate the value of a business for four primary reasons:

1. Tax – for settling of an estate or for gifting shares in a business.
2. Divorce settlement
3. Sale of a business
4. Settling a shareholder or business dispute

Whatever the trigger may be, my job is to be thorough in analyzing the business and substantiating how and why the valuation amount was determined.

A site survey is an essential part of substantiating ‘why’ I came to the conclusion I did about the value of the business and with the right expertise and proven process, site surveys need not be done in person.

A Component of a Proven Process

The valuation analysis includes both quantitative and qualitative factors. The site survey is part of the process to confirm basic information about the business including its existence as well as to confirm its physical attributes. I have leveraged site surveys to confirm physical assets on the property as well as organization, cleanliness, room to support growth, etc.

Leveraging technology, I have conducted virtual site visits and management interviews for years via guided video tours enabling me to assess a business and capture the same information I would capture if I was completing a site visit in-person. Using technology, I can ask questions of my tour guide and obtain images as input to developing the business valuation report.

Technology enables us to be efficient, while adhering to our proven process ensures that a virtual site survey does not compromise the information needed to develop a thorough and complete valuation. It has been my experience for many years that conducting effective virtual site tours is not only possible, but with our proven process it is easily repeatable to serve our clients across the United States and in other countries.

It comes down to expertise and a proven process. Geography need not be a top criteria for choosing a business valuation professional. To learn more, read our recent blog that includes the 3 criteria to focus on when needing a business valuation. A proven business valuation professional knows precisely what information is needed from a site survey and can adeptly gather and analyze that information effectively virtually.

When Values Matter.

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If you are in need of a business valuation, whether to settle an estate or divorce or for a business or shareholder dispute, criteria for selecting the business valuation professional need not consider geography. Similar to a recent blog regarding industry specialization, neither industry or geography matter.

As a certified business appraiser, I have prepared business valuations for privately held businesses throughout the United States; from Maine to Hawaii and North Dakota to Texas. Internationally, I have developed business valuations for businesses in more than fifteen different countries.

Through decades of experience and by leveraging technology, business valuations can be thoroughly and completely prepared remotely. I can and do conduct business as efficiently and effectively with a business owner in Andover, MA as I do working with a business owner in Houston, Texas. Documents are easily and safely shared electronically and for businesses where site visits are relevant, I have and continue to successfully conduct site visits remotely. During the pandemic, site visits were not possible as businesses were shut down or access was limited for the safety of the employees. In such cases and for businesses not located nearby, I have successfully completed ‘site visits’, including for a scuba diving business in Hawaii, gathering the important data needed to finalize the business valuation.

Instead of limiting your search to a professional who is close to you geographically or who has prepared business valuations in your industry sector, I encourage you to focus your evaluation of a business valuation professional on the following 3 most important criteria:

1. Credentials. Are they certified? Do they have the credentials to demonstrate their understanding of business valuation? One way to assess this could be asking the professional if this is their full-time focus. That can be an indicator that the professional has dedicated his or her career to remaining current on tax laws and business valuations are their sole focus. Ask the professional for their credentials specific to business valuation, and specifically look for the following certifications: CBA, ASA and/or CVA. Note: CPA is not sufficient.
2. Track record. Does the business valuation professional have a proven track record demonstrating their business valuations stand up to rigorous scrutiny? They should be able to clearly speak to the track record of testifying in court as one example and what the results were.
3. Proven process. Does the business valuation professional offer a proven process and methodology that is consistently applied regardless of the business or industry? Process is important as it is the process that converts to the final deliverable. When an ‘industry professional’ presents to the trier of fact a 1 page business valuation report and the trier of fact compares that to our 100+ page business valuation report documenting what was done, why it was done, how it was done, conclusions drawn and why those conclusions are reasonable and credible, there is no comparison.

For a recent interesting case study on valuing mineral rights on property in North Dakota, click here.

When Values Matter. Geography Does Not.

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It was great to be at the 2022 International Business Brokers Association (IBBA) Annual Conference in Denver, Colorado earlier this month. It was the first conference I had been to since the pandemic started and the attendance was the largest ever for the conference with over 700 attendees!

So, while gas prices and inflation rise and the war in Ukraine continues, the IBBA conference brought a sense of normalcy with so many business brokers and M&A professionals networking, learning and sharing insights and observations on the market and the industry.

As a member of the IBBA Board of Governors and the Education Committee, I see first hand how much time and effort goes into planning such a conference. The Executive Director and her team did a wonderful job to plan and execute a high quality, high energy event.

At the event, I was honored to be one of two recipients of the 2022 Fellow of the IBBA lifetime award for professionalism, achievement, and service. It has been an honor to be part of this organization.

With Spring’s arrival here in New England, I look forward to more signs of normalcy.

Business valuations can have a significant impact in the outcome of important matters in one’s professional and personal life. Important matters requiring an opinion of value may include the division of assets for a divorce settlement, shareholder dispute, gifting shares, or settling an estate. From taxes to settling a shareholder dispute, a business valuation can factor significantly in the outcome of the matter at hand.

When it comes to such matters, it makes sense to make an informed decision when choosing the right professional to prepare the business valuation. If you or a friend needed a medical opinion, you would likely seek out a professional who had the experience and credentials that are applicable to the specific medical condition. It would not make sense to seek the advice of a dentist for a foot condition, even though the dentist has a medical degree.

When seeking tax advice, most would turn to their CPA. But does turning to a CPA to develop a business valuation make sense? The accounting and business valuation professions are two different disciplines. In fact, the American Institute of Certified Public Accountants (AICPA) recognizes this and offers additional training and accreditation in business valuation for those accountants who want to prepare business valuations.

Business valuation professionals are governed and certified by separate organizations as the discipline of business valuation has its own set of rigor and standards. As the IRS indicates, a “qualified appraiser” is an individual who has earned an appraisal designation from a recognized professional appraiser organization; for business valuation the designations that meet the requirements of a qualified appraiser include CBI, CBA, ASA, CVA, or ABV. A qualified appraiser does not include the designation of CPA. Lou Pereira has earned four of these designations including being a Certified Business Appraiser (CBA), from the Institute of Business Appraisers (IBA) of which there are fewer than 12 in New England and fewer than 200 across the United States.

Choosing a professional to prepare and present a business valuation is an important decision. It is advised that you do your research as the result can be significant in terms of the awarded dollar value whether from arbitration, settlement, or a court ruling. Read how values matter in a divorce case when separate valuations were prepared by a credentialed business appraiser and a CPA. Read how the settlement of an estate was affected when a CPA was hired by one party to prepare the valuation and how that fared against the valuation prepared by a Certified Business Appraiser.

When Values Matter, Credentials Matter, too. Do your homework and get the right credentialed professional preparing the business valuation.

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Are you thinking about retiring or selling your business in the New Year? If so, getting a business valuation should be an essential component of your plans.

Certified business appraisers can help facilitate a business sale by determining the fair market value of a business. This avoids leaving money on the table, so you can get the best possible value.

When values matter during a business sale, we recommend receiving a thorough business valuation depending on your unique situation, including:

• If you’re starting the sales process, reach out early to a certified business appraiser, who can thoroughly assess all factors that might impact the business valuation.
• If you’re already in the process of negotiating a sale, get a certified business appraiser involved as soon as possible, in order to resolve any potential discrepancies in value.

A recent business valuation was prepared when negotiations for selling a business stalled over the sales price and securing financing. The buyer had relied on a CPA firm that had valued the business at $800,000. A certified business appraisal substantiated the value of the business, enabling the seller to make a substantial amount more on the sale and the deal was closed at an expedited pace, minimizing further buyer due diligence and reducing costs. Read the case study.

Values Matter when selling a business. If you or someone you know is thinking about selling a business in the New Year, contact us to not leave money on the table. A business valuation is an essential part of the plan and should be planned well in advance of a transaction. We offer a free and confidential consultation to help determine next steps for your unique situation.

We have built our reputation on preparing detailed, defensible, and thorough business valuations for small and mid-sized privately held companies. When values matter, it is important to have an objective, certified business appraisal that will stand up to scrutiny and, in this case, IRS compliance.

A recent business valuation that we prepared had a number of factors contributing to the complexity of the valuation, including but not limited to:

• Fractional ownership of the business
• Multiple entities comprising the business being sold
• Charitable contributions by a fractional owner including determining the total dollar value and per share value
• Tight timeframe for sale of the business to a strategic buyer

Read the case study.

When Values Matter: If you or someone you know needs a business valuation for taxes, divorce, selling a business, or resolving a shareholder dispute, contact us to obtain a thorough business valuation that will stand up to rigorous scrutiny.