Category: Uncategorized

A question I am asked frequently is: Can this business be valued?

I have written multiple blogs recently on various scenarios including:

• Part 1: Valuation of a business that has been operating for years, but with incomplete or poor financial data.
• Part 2: Valuation of a start-up
• Part 3: Valuation of a nonprofitable business

Then I realized there is another category of business: businesses that are worth more closed than continuing to operate.

This does not necessarily mean the business is not profitable. The business is typically technically viable, generating income and in some instances, profitable. That is why they do not fall into the category of the businesses discussed in Part 3 of this blog series.

So what is going on that makes a business more valuable shut down?

Often the business has been operating for many years. The owner or owners are satisfied with the income derived from the business. In many cases the real estate associated with the business has appreciated significantly over the years. Additionally, for many businesses in this category, other assets, including heavy equipment, have been acquired over the years and the metal itself has value.

An overview of determining value of these businesses

In prior blogs in this series, I emphasized the importance of financial forecasts as an important starting point in the valuation process. In these circumstances, the forecast reveals the business is not viable. Applying the asset approach to valuation, I focus on the underlying assets of the business where real estate and equipment tend to be the business’ most valuable assets. Valuation is determined based on establishing the liquidity value of each asset, including real estate. The result of the detailed valuation analysis is that the business is worth more by closing and liquidating its assets than it is by continuing to operate.

Common triggers for valuing such a business

As one would expect, one trigger for needing a valuation of a business in this category is bankruptcy. The valuation is leveraged to determine payouts to debtors.

Another trigger for needing a valuation of a business that is worth more closed than continuing to operate is when the business is losing money and the situation is not fixable. Like the bankruptcy situation, the viable option is liquidating the business. The business valuation is the sum of the value of the underlying assets of the business.

The other trigger is settling an estate. Usually, the business has operated for many years and the owner or owners were satisfied with the income generated and their modest lifestyle. To settle the estate, the valuation of the business determines that more value would be generated by closing the business and liquidating the assets than continuing to operate.

Conclusion

As these four blogs have described, any business can be valued. The key is to secure a certified business appraiser, a professional who focuses on business valuation, with a proven track record and process so that the valuation is objective, thorough, and defensible should it need to stand up to scrutiny.

Whether selling or buying a business, allocating assets as part of a divorce, settling an estate or settling a shareholder dispute, when you need a business valuation, contact us.

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A common question I am asked is: Can this business be valued?

In the first blog in this series, we focused on determining the value of a business that has been operating for years, but with incomplete or poor financial data. The second in the series focused on valuation of a start-up. And finally, this third blog is how to determine valuation of a nonprofitable business.

How do you determine the value of a business that is not profitable?

Forecasts are an important starting point in the valuation as written about in Part 2 of this series. A forecast is still relevant and an important factor in developing the valuation for a business that is not profitable. The reality is the value may be determined to be zero or negative should debts exceed valuation. In this situation, the seller may be interested in securing the tax benefits of a zero or negative valuation.

Typically, there are two scenarios when determining the valuation of a business that is not profitable. The value is tied to the people, or the business value is largely driven by an idea. Talented people and disruptive ideas are value drivers in a business and the use of public data can support the valuation of people and/or a disruptive idea.

In either situation, the valuation is developed by gathering and analyzing available information. The valuation prepared answers the question: how would a hypothetical buyer evaluate this business?

My thorough process leverages public data about businesses with talented teams and/or valuing an idea before it has been taken to market. Risk is then applied as it is especially important when calculating the value of a non-profitable business, similar to a startup. With expenses exceeding revenues, a higher level of risk will be applied.

Conclusion

Over the decades of developing business valuations that stand up to scrutiny, I have prepared detailed business valuations for firms having zero revenue as well as for business owners having an idea, but no product or service.

Determining the value of a non-profitable business can be done and is done with relative frequency. While not the most common situation I encounter, the steps to preparing a thorough and objective business valuation remain the same. Available public information, market information, and experience all support developing financial models that withstand the reasonable test and apply a risk factor to determine the valuation applying the discounted cash flow method.

If you are wondering if your business can be valued, you now know the answer is yes. Now it is important to secure a certified business appraiser with the knowledge, proven approach, and experience so that the valuation is thorough and defensible.

When values matter.

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A common question I am asked is: Can this business be valued?

In the first blog in this series, the focus was on determining the value of a business that has been operating for years, but with incomplete or poor financial data.

The focus of this blog is on valuation of a start-up business.

How do you determine the value of a business in its infancy?

The starting point is the business owner’s forecast. Business owners typically have a forecast of projected revenues, expenses, capital expenditures, and income. The ideal starting point is having an income statement and balance sheet for the next ten years. The reality is the business forecasts I start with vary considerably: some may be a profit and loss statement for the next three years, with no balance sheet forecast. Whatever the owners have is my starting point and the ideal is rarely what I am starting with to prepare the valuation of a start-up business.

Building the Forecast

My next priority is to expand on the forecast from the business owner(s) and work with management to fill in the gaps. Sometimes capital expenditure planning is scant, or assumptions for market penetration, number of clients, or average revenue per client are needed for me to further expand the forecast.

Building and expanding the financial forecast is the foundation for developing the business valuation. While rudimentary valuation approaches may simply average the last three years of revenues and net income, venture capital firms and prospective buyers of a business are unlikely to accept this simplified calculation. Given the pandemic and its far-reaching effect on industries and businesses, an average of the past three years of revenue and net income is unlikely to represent a future business’ performance. The financial model I build looks forward, documenting key inputs and assumptions to pass the reasonableness test.

Factoring in Public Data & Risk

After working with management to augment the forecast, I turn to analyze public data. Useful public data includes price to earnings ratios as well as public information to incorporate into a regression model regarding returns based on the business’ financing stage.

Risk is applied when determining the value of any business. It is especially important when calculating the value of a start-up business. There may be no revenues and no history to support the forecast. That is where a higher level of risk will be applied.

Accounting for risk is factored into the discounted cash flow analysis. We have long embraced the discounted cash flow method, an approach that more business valuation professionals now utilize. This is the most accurate method. Once the forecasted financials have been expanded/developed in the above-described steps, now we factor in risk. The higher the level of uncertainty, the higher the rate used to discount the projected earnings.

Public data enables me to analyze rates used in valuing companies based on financing stage. A company with two to three rounds of financing will have a lower risk factor than a company at the seed level stage for financing. For self-funded start-ups, the financing stage is irrelevant, so risk excludes public financing data, but accounts for market and business risk inherent to the business.

Conclusion

Over the decades of developing business valuations that stand up to scrutiny, I have prepared detailed business valuations for firms having zero revenue as well as for business owners having an idea, but no product or service.

Determining the value of a start-up business can be done and is done frequently. Available public information, market information, and experience all support developing financial models that withstand the reasonable test and apply a risk factor to determine the valuation applying the discounted cash flow method.

If you are wondering if your start-up business can be valued, you now know the answer is yes. Now it is important to secure a certified business appraiser with the knowledge, proven approach, and experience so that the valuation is thorough and defensible. You have put a lot of time and effort into your start-up, do not sell the business short with an overly simple calculation.

When values matter.

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It’s that time of year when taxes are top of mind. No one wants to pay more than is required. Business valuations can have a significant impact on tax liability and IRS compliance. Read a few examples below of the importance experience and expertise have in achieving the desired outcome.

1. The Risk of Double Taxation

Eight owners of a C-corporation were preparing to sell the business. The transaction was at risk as its structure as an asset-based sale put the owners at risk of significant tax liability in the form of double taxation.

The owners needed a business valuation to determine fair market value and total goodwill to restructure the deal and minimize tax liability. Lou Pereira developed the business valuation and then built a multi-variate model to calculate each owner’s goodwill. With the valuation, modelling, and analysis completed by Merrimack Business Appraisers, the deal was restructured, and double taxation was avoided.

Read the case study.

2. Compliance with IRS Section 409 and Reducing Tax Liability

Like many businesses, attracting and retaining talent was a priority for this rapidly growing company on the west coast. This company was experiencing hypergrowth and included in its compensation package stock grants to attract professional executive managers.

The firm’s owners contacted Lou Pereira to develop a business valuation of the stock to comply with IRS Section 409A. Lou’s methodical and thorough valuation substantiated the value determination, satisfying the stringent requirements for Section 409A compliance.

Please read more about how the tax liability for the company was reduced.

3. A Sale & Donating Shares to Charity to Minimize Tax Liability

Two owners of a business decided to sell their business. One of the owners wanted to donate proceeds from the sale to charity to minimize his tax liability. To the average person, this may appear straightforward, but Lou Pereira was fully aware of the IRS requirements for charitable contributions. Incorrect sequencing and timing of actions could result in the IRS disallowing the charitable donation as part of the sale.

Lou Pereira prepared the business valuation, including determining the value associated with the shares donated to charity. The sale was completed and all actions were executed for the seller to achieve his goal of securing the tax deduction, minimizing tax liability and supporting the charity of his choice.

Please read more about this case.

Contact a proven certified business appraiser to prepare a thorough and objective business valuation that can stand up to scrutiny, including the IRS.

When Values Matter. Expertise Matters.

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I am regularly asked if this business can be valued. This blog is the first in a series of blogs to explain how value is determined, with the focus being on valuing a business that has been operating for years, but has incomplete or poor data.

This situation is quite common. In fact, it is the nature of small businesses. The owner runs the business with most of the information in their head. For purposes of this blog, the owner passes away and I am contacted to develop the valuation of the business to settle the estate.

In reviewing the available financial information (e.g., P&Ls, balance sheets), it is clear the financials are incomplete. Given the business had been successfully operating for many years, I have a higher degree of confidence in the functioning of the business, but I will have to recreate the financials and in many cases restate the financials. My focus is to first assess what is available that I can leverage and then to leverage other available information that would fill in the missing components. A guide to how this is done is to ask, ‘what information would be available to a hypothetical buyer of this business?’

Determining the valuation of a business with an operating history is possible and not as uncommon as you may be led to believe. Many family businesses and privately owned businesses may not have consistent and complete financial records over the course of operating. That does not mean your business can’t be valued. It can.

My work is guided by the same process that I follow for a business with well documented financial statements. The difference is applying a risk factor based on what information is available and what information I have had to determine to the best I could. In the case of very poor data, the risk factor will be higher as I have less confidence in the available data to determine the valuation. But, for businesses successfully operating for at least 5-7 years, there is typically sufficient evidence and available information to confidently determine the value.

So if you are wondering, can my business be valued? The short answer is yes. The methodology I follow remains the same, but when information is poor or incomplete, research and analysis is important to leverage any available data to recast, recreate, and build the valuation model to ensure the determined value will stand up to scrutiny.

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Over the years, I have taught accounting and finance classes at Fitchburg State University, Southern New Hampshire University, and Franklin Pierce College. When asked, “Why do you teach?” it prompted me to think about the profound impact teaching has had on me and the ongoing benefits to my profession as a certified business appraiser. It is especially top of mind as I take on a new teaching challenge in 2023.

My Teaching Journey

It started back when I was in the Army. Ongoing learning was a focus in the Army as we would teach a new skill in a classroom setting. Then early in my corporate career, I expressed the desire to improve my presentation skills. A seasoned professional advised me to teach, noting that teaching required you to learn the materials and develop an effective way to present the material. I took his advice and started teaching at Franklin Pierce University in their adjunct college, teaching working adults on weekends.

In my early days of teaching, I stayed one chapter ahead of the students, working to master the content and plan the lectures. Over time, I became more comfortable with the process and particularly enjoyed thinking on my feet as students asked about concepts or in some cases, questions out of nowhere!

I then started teaching in the evening program for undergraduate students at Fitchburg State University, my alma mater, teaching every course in the accounting curriculum. I thoroughly enjoyed this experience, getting to know the accounting majors as they progressed through the curriculum. I still remember writing a job recommendation for an undergraduate accounting student who went on to get his MBA and CPA, working for PWC. Witnessing this accounting student’s professional advancement and experiencing students in their ‘aha’ moments when concepts clicked, those are wonderful rewards of teaching at night and on weekends while working full-time. Teaching at my alma mater was a special form of giving back to a community that had helped shaped me.

As many people know, I like to talk. That is another reason why I teach. I enjoy sharing ideas and hearing what the students think. It has been particularly rewarding to teach veterans, single mothers, and first-generation college students. They have a thirst for learning, a palpable desire to succeed and a commitment to actively participate in the learning process. Plus, they bring their life experiences to the classroom for a dose of reality and welcome perspective.

Going Virtual

When the pandemic hit, teaching changed. While the learning objectives and homework assignments remained the same, the delivery mechanism and how to present effectively changed. It was imperative that I adapt quickly to improve my delivery, offering a quality learning experience to the students amid so much change and uncertainty. Like others, I was learning on the fly on how best to teach virtually including engaging and communicating with the students. Recording classes and incorporating on-line discussion boards to help students throughout the course became part of my teaching style.

Mastering Curriculum Development – The Next Level in My Journey

The pandemic led to the International Business Brokers Association (IBBA) seeking to take its continuing education program to the next level. As a member of the IBBA’s education committee, I had taught multiple courses in the past at the IBBA’s annual national conference which I had very much enjoyed. The organization is a collaborative organization that places great emphasis on continued education, which I respect and thoroughly embrace as a professional. But this was, once again, a learning opportunity for me. The IBBA sought a higher-level education opportunity for its experienced members who had earned their highest certification, Certified Business Intermediary (CBI) designation. This was taking my teaching to the next level as I was developing the curriculum in addition to teaching as the Master’s Program launches this year. This was another milestone in my teaching journey as the curriculum is mine.

The Intersection of Teaching & Presenting as a Business Appraiser

I have attained the highest level of certification available for a business appraiser. That is not by accident, but as I reflect on my journey, that is fueled by my desire for continuing to learn and improve. While it is essential that I stay current in my profession, I have benefitted greatly from my teaching experiences. I have gained the skills of documenting and presenting large amounts of information in a clear and logical manner, which has served my clients well. Being able to explain complex concepts in a clear and understandable way helps students learn. It also helps attorneys and judges understand how I have arrived at the business valuation presented in a document and in a courtroom.

As I reflect on that advice received many years ago that I should teach to hone my presentation skills, I am struck by how that advice has affected my life. While I know I will continue to push myself to learn and grow, I am humbled right now to prepare and deliver these master courses as part of this 10-month virtual cohort learning program for experienced and credentialed business brokers looking to take their careers to the next level. My immediate challenge is to foster structured discussion, keep the pace, and deliver tremendous value to accomplished business brokers. And as I have learned over the years, I will learn a great deal from them to refine my curriculum, improve my skills, and continue my teaching and learning journey.

Why do I teach? It is rewarding, challenging, and keeps me on my toes.

Louis J. Pereira has completed the most intensive training in the country and earned the highest designations available in the field of business valuations. There are fewer than 200 Certified Business Appraisers in the country and Lou is one of them. In New England, Louis J. Pereira is one of only a dozen having earned the rigorous designation of Certified Business Appraiser. Learn more about Lou Pereira here.

When Values Matter.

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We turn the calendar and we face the unknown. For some, it is a time of excitement and anticipation while for others, a source of uncertainty and foreboding.

What will the New Year bring for you and your business? More importantly, are you taking charge to make 2023 your year?

If selling your business is top of mind for 2023, there are three points to consider:

1. Taxes
2. Your business COVID-19 story
3. Demand

Taxes

As the saying goes, nothing is certain, but death and taxes. As we look ahead, it is certain that tax rates will increase as tax laws are set to expire. This includes the expiration of tax laws that promoted business deductions (e.g., Section 199A) for select industries, directly increasing tax liability of businesses in the coming years. Additionally, the Massachusetts Millionaires Tax went into effect this year.

If you are thinking about selling this year or prior to the expiration of such tax incentives at the end of 2025, now is the time to review and revise plans for your business including tax and estate planning. Gifting shares is an effective way to transfer ownership of your business to the next generation or to trusted employees, while effectively managing tax consequences.

Your Business COVID-19 Story

We now have enough data to tell your business COVID-19 story. Just like back in 2001, 2003 and 2007, there is sufficient evidence to determine which of the following five categories describes your business COVID-19 story:

1. Wounded and will die
2. Wounded and will recover
3. Not affected
4. Temporarily did better and then levelled off. (e.g., restaurants that pivoted to focus on take-out)
5. Did better and then turned success into a strategic advantage, gaining market share.

What category represents how your business did? As business valuation professionals, we now have enough data from the start of the pandemic through today to tell your COVID-19 story. Sufficient data of nearly three full years supports presenting the impact of such unusual times while reporting how your business performed as the months continued. The data will tell your COVID-19 story and the business valuation will present the objective details of your businesses performance over time.

As we know, the pandemic was the last straw for many baby boomers, who sold and retired at a record setting pace. Understandably, the pandemic was a reality check; a vivid reminder of the fragility of life and the importance of aligning values and priorities with one’s work life. This priority remains important which leads to the third consideration: demand.

Demand

The most common concern of a business owner is often, who would be interested in buying my business? If you are considering selling your business, you can assume there is interest in your business. Demand is there and it falls into two primary categories:

1. Buying a job: many buyers are looking to buy their next job. The pandemic raised the focus of achieving that elusive ‘balance’ and where businesses are forcing a return to the office or ramping up travel or other demands, individuals are balking and seeking to buy a lifestyle that suits their priorities.
2. Private equity firms: there is a lot of money held by private equity firms seeking to acquire businesses.

Conclusion

For most business owners, the process to sell does not happen within a 12-month period. It is a longer process to address and improve the balance sheet, develop a succession plan, and focus on driving value. However, that does not mean that this cannot be your year. Three key considerations, briefly described above, all point to the favorability of making 2023 the year to act. Taxes will increase so you have a window of opportunity. Your COVID-19 story is known, and there is likely demand.

Should this year be your year, contact us if we can assist you in achieving your goals by developing a business valuation.

When Values Matter.

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