by Greg Caruso | Apr 2, 2025 | ESOP Business Valuation, Estate and Gift Tax Business Valuation, SBA Business Valuation and Appraisal
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Art of Business Valuation is a sponsor for this event.
by Greg Caruso | Mar 18, 2025 | ESOP Business Valuation, Estate and Gift Tax Business Valuation, SBA Business Valuation and Appraisal
Running a business during uncertain times can be challenging, but it’s not impossible. Changes in the economy, politics, unexpected events, and new technologies can make planning and successful operations hard. However, businesses that stay flexible and adapt quickly have a better chance of surviving and growing. To do this, business owners must be ready to change their plans and respond to new situations rapidly.
One key strategy is to review and adjust business plans regularly. This includes thinking out contingency plans for unexpected but possible change. Markets and customer needs can shift quickly, so businesses must keep an eye on trends and be ready to pivot (and you thought pivot ended with Covid) when needed. Being open to change allows companies to take advantage of new opportunities while limiting potential risks. Staying informed and making small adjustments over time can help businesses remain stable and competitive.
Another important factor is building a strong foundation. This means planning, building your balance sheet to survive emergencies, and ensuring business operations can continue even when problems arise. Building a management team that works together provides resilience and internal forums for problem-solving. Companies should also have a variety of suppliers and customers to avoid concentrations that increase risk and can quickly put a firm out of business. Planning can help companies to stay strong, even when unexpected challenges occur.
Finally, good leadership is crucial during uncertain times. Business owners and managers should communicate openly with their teams and encourage problem-solving. Employees who feel supported and valued are more likely to stay motivated and help the company succeed. Leaders should also take care of themselves, as making good decisions under pressure requires a clear mind.
With the right mindset and approach, businesses can not only survive tough times but come out stronger.
by Greg Caruso | Feb 22, 2025 | ESOP Business Valuation, Estate and Gift Tax Business Valuation, SBA Business Valuation and Appraisal
You need a business valuation or a business appraisal. You might need the business valuation for Estate and Gift business taxes, applying for an SBA loan, ESOP stock value, or a host of other reasons. How can you make sure that you obtain the most accurate business valuation possible?
The business valuation is going to tell a story about your business. This story will contain a narrative backed up by statistics, facts, and figures. This story must make sense when it is complete. Your job as a business owner obtaining a valuation is to make sure the story, facts, and figures are clear and sensible to the experienced valuation professional appraising the business.
Below are 5 steps business owners should take to make sure your business valuation is as accurate as possible.
THE 5 STEPS
- Be able to explain why your product or service is so desirable you can continue to make a high profit
The most important thing in valuing your business is understanding how you create and keep a market of customers that will pay enough for your product or service that you can be expected to continue making a profit. Do you have patents keeping others out? Do you have a unique distribution channel? Do you have better internal systems and people? This is the core of the business valuation. How your business makes money and how it will continue to do so. The ability to clearly and succinctly explain that is key to the valuer understanding your business and getting the valuation correct.
- Have quality financial information.
You must have quality financial information. A business valuation is, to a large extent, a review of your past financial results and a projection of your future financial expectations. Without clear data it is very difficult to see the details necessary to make correct assumptions and calculations. In addition to historic financial information, business plans and useful projections consistently kept will add to the valuer’s understanding of the business.
- Have leases and major contracts in good order
Leases, customer contracts, loan documents, and the like may not make a business, but if they are not in good order a business may suffer major losses quickly. These documents in good form reduce risk which increases value. Have the major legal documents your business relies on updated and accessible, so you can provide them when asked.
- Have systems outlined and resumes of key people
Simply put, a business is a series of systems that produce a product or service, hopefully at a profit. Most businesses have many systems that are run by people. True high-quality systems are where “normal people obtain extraordinary results every time.” This requires great systems, great training, and very good people. Make sure you can document all of these.
- Hire an experienced valuation professional.
Clearly, the valuer must have the background to understand how actual businesses on the ground work and how that translates into value. Business valuations are performed for specific purposes – sales, SBA loans, ESOP structuring, divorce, Estate and Gift Tax. While it might sound crazy, it is a fact that the purpose can often significantly change the correct business value found. Make sure the valuer understands and has performed valuations for your purpose. Finally, make sure they have sufficient background and training in the fundamentals of business valuation.
These five steps lead to a consistent well-run business and obtaining a correct business valuation. Business valuation does have an element of the old saying, “garbage in – garbage out.” As a business owner you do play an important role in obtaining a proper business valuation.
by Greg Caruso | Jan 21, 2025 | Estate and Gift Tax Business Valuation
The recent Supreme Court case, United States v. Connelly, has significant implications for businesses and their estate tax planning. The Court ruled that life insurance proceeds held by a company must be included in its valuation for estate tax purposes, even if those proceeds are earmarked for a stock redemption.
Imagine it this way: You have a house, and you have homeowner’s insurance that covers the replacement cost of the house. A similar ruling by the court would say the value of that insurance policy itself adds to the overall value of your house for tax purposes, even though it’s there to protect you, not increase your property value. We can all be relieved this is not currently true.
This ruling, however, is a game-changer for businesses. It means that life insurance policies held by a company are no longer considered “off the books” when it comes to taxes. So, businesses need to get creative to avoid a hefty tax bill down the road. It’s super important for owners and their advisors to review their buy-sell agreements and estate plans to make sure they’re still set up to minimize tax liabilities.
The good news? There are ways to work around this.
- Different insurance setups: Instead of the company holding the insurance, owners can buy policies on each other, which can keep those payouts out of the company’s valuation.
- Trusts: Putting insurance policies in a trust can also help keep them separate from the company’s assets.
Read More in Greg’s article for NACVA QuickRead: Valuation Lessons from Connelly v. United States
by Greg Caruso | Dec 5, 2023 | Estate and Gift Tax Business Valuation
In the realm of estate and gift tax valuation, the concept of Discount for Lack of Marketability (DLOM) plays a crucial role in determining the fair market value of closely held business interests. The DLOM reflects the reduced value of such interests due to their limited marketability compared to readily tradable securities like publicly traded stocks.
Originally developed to assist Internal Revenue Service (IRS) engineers, the DLOM Job Aid is also used by appraisers and valuation professionals in navigating the complexities of DLOM determination. This guide provides valuable insights into the factors that influence DLOM and offers guidance on applying the DLOM to various valuation approaches.
Understanding the IRS Job Aid for DLOM
The IRS Job Aid for DLOM outlines nine key factors to consider when evaluating the DLOM for a closely held business interest. These factors include:
- Financial statement analysis: The financial health of the company plays a crucial role in its marketability.
- Dividend history and policy: A consistent dividend history and policy enhances the attractiveness of the shares to potential investors.
- Nature of the company: Factors like industry, track record, and market position influence marketability.
- Company management: The experience and reputation of the management team affect marketability.
- Amount of control in the transferred shares: Controlling interests are more marketable than minority interests.
- Restrictions on transferability: Restrictions like buy-sell agreements reduce marketability.
- Holding period for the stock: Longer holding periods may warrant a higher DLOM.
- Subject company’s redemption policy: The frequency and terms of redemptions affect marketability.
- Costs associated with a public offering: The costs of taking the company public reduce the net proceeds to shareholders.
Discounting serves as a valuable tool for determining fair market value for tax or estate planning purposes.
Applying the IRS Job Aid to Estate and Gift Tax Valuation
- Thorough Familiarization: Begin by thoroughly reviewing the IRS Job Aid to gain a comprehensive understanding of the DLOM concept, the factors that influence DLOM, and the various methodologies for applying DLOM.
- Valuation Approach Selection: Identify the appropriate valuation approach for the specific business being valued. Common approaches include Discounted Cash Flow (DCF) Analysis, Comparable Transaction Analysis, Guideline Public Company, and Capitalization of Income Approach.
- DLOM Factor Analysis: Apply the nine DLOM factors outlined in the IRS Job Aid to the specific business being valued. This involves evaluating each factor and documenting its impact on marketability.
- DLOM Quantification: Based on the analysis of the DLOM factors, quantify the appropriate DLOM percentage to be applied to the valuation. This may involve utilizing comparable DLOMs from similar businesses identified through qualitative evaluation such as Mandelbaum Analysis or applying valuation models including quantitative methods and Options Models that incorporate DLOM adjustments.
- DLOM Integration: Integrate the quantified DLOM into the chosen valuation approach. For instance, in DCF analysis, the discount rate could be adjusted to reflect the DLOM.
- Documentation: Thoroughly document the DLOM analysis, including the identification of relevant factors, the rationale for quantifying the DLOM, and the application of the DLOM to the valuation approach.
The IRS Job Aid for DLOM serves as an invaluable resource for appraisers and valuation professionals involved in estate and gift tax valuations of closely held businesses. By carefully considering the DLOM factors and applying the guidance provided in the Job Aid, appraisers can ensure that their valuations are well-supported, defensible, and compliant with IRS guidelines.
by Greg Caruso | Oct 27, 2021 | Estate and Gift Tax Business Valuation
Valuing small business using financial statement evaluation and ratio analysis (quantitative analysis) can be difficult because companies do not tend to follow industry or GAAP standards. Even when cash flows are correct, other financial information may not compare well with available data. This means the business valuator must put more emphasis on understanding how the business really works beyond the numbers (qualitative analysis). This way, the valuator can determine if the business has resilience. Resilience allows the company to survive and thrive when roadblocks appear. This means that the business is more likely to meet financial forecasts, reducing risk. Here are a few soft factors that business valuators can review as part of proper qualitative analysis when quantitative analysis is not available.
What are the components to business valuation?
There are two main components to valuing a business. The first is forecasting future cash flow. Then, we determine the risks and likelihood that the risks will reduce the expected cash flow. We address risk using the discount or capitalization rate or the multiplier. The two components, cash flow and risk, are somewhat inseparable. For example, if we forecast a very high cash flow for a company, the risk of meeting the cash flow automatically goes up to some degree. In every business valuation the factors that should be reviewed and the impact on risk to the company can vary.
What are the qualitative or soft factors to review in business valuation?
What are the cash flow trends over time?
High margins and growth usually portend more good things.
What is the management structure and the size of the company?
Owner/operators who do everything create risk. If something happens to them, the business might be in a lot of trouble. Furthermore, most buyers do not want to stock shelves if the stock person does not show up.
What are the concentrations?
As I have said many times, concentrations kill. Yet small businesses are always going to have some. Concentrations can include geography (New York City was a much worse place to have a sit down restaurant in 2020 than most of Texas), management, suppliers, referrers, keywords (many an internet company lost profitability when keywords got too expensive), suppliers, referrers, customers, etc. For a small business, each of these create more risk than with larger companies in the same industry. They might even be way beyond what the typical small company comparable might have. For instance, we would have to adjust for more risk when comparing a commercial landscaper with only a few large clients to the typical landscaper with large number of smaller clients.
How well is the company organized?
Organized companies with standardized processes that work every time are much stronger and deserve high business valuations than when a few people make all decisions shooting from the hip. Remember what my dad said: “Great systems exist when average people get extraordinary results every time.”
What is the workforce and employee base like?
Traditionally, many industries have placed an emphasis on management. However, having a loyal, well-trained workforce increasingly brings strong value. In a technical world, ramp-up time and training costs can be significant. This can be reduced if a qualified workforce is in place.
What is the company culture like?
Company culture can be very hard to assess. But some companies have a culture of overcoming problems and obstacles, which can be an asset. This is an important asset. A motivated can-do company culture greatly reduces risk. But be aware, it can change as management changes.
Most of these quantitative factors in business valuation are hard to assess and translate into numerical risk assessments. (Eventually we do have to work it into our quantitative analysis.) Unfortunately, much of it will never get beyond the claim of professional judgement. In fact, it is why professional judgement is more important in small business valuation than many other accounting and finance functions. Sometimes it is easy to see the advantage, but hard to assess an exact increase or decrease due to the complex interplay of factors. For instance, problems that might be a small bump in a fast growing economy could be the kiss of death in a recession.
This is why I say that business valuation is an art and a science. If you have questions about business valuation for SBA loans or planning and exit or succession, estate and gift tax, or ESOP’s contact me today.
Gregory R. Caruso, Partner, Harvest Business, LLC t/a The Art of Business Valuation.
