Placing a value on your small business is a complicated process. Business Valuation experts have several methods available to do so:
- Asset Method: looks at the small business’ assets and liabilities at book value and market value.
- Income Method: projects annual income/cash flow earned by the business and uses that to calculate a value by capitalizing that income based on risks and opportunities.
- Market Method: compares your business to other comparable sales and value obtained
These methods are much more complex than I’ve made them sound. However, they’re really just the first step in figuring out a business’ value for estate-planning purposes, albeit very important first steps!
Ownership – Premiums and Discounts
The next step in valuing a business is to apply certain premiums or discounts based upon each member’s ownership level. Differences in control and marketability must be considered based on how much control one has in strategic direction of the business as as well as how easily one can sell their interest.
To illustrate control, a 51% interest in a business would be worth more to a buyer/seller because 51% is a controlling interest in the business and that member can make decisions that affect value over time (positive or negative). In contrast, a 10% interest in that business would be worth less than 10% because the owner of the 10% interest lacks any level of control over the business.
To illustrate marketability, for most small businesses, there isn’t a liquid market where the business can be easily sold in a few days. Therefore an interest in a private company isn’t worth what it would be if it were listed on a stock exchange.
Your Estate Plan
These premiums and discounts are an important consideration when valuing your business and in crafting an estate plan. Obviously, the value of any business interest you own at your death will be included in your gross estate for estate-tax purposes. So, if your business is worth enough that, combined with your other assets, you might be liable for estate tax, you want to have a plan that minimizes or even eliminates that liability. The valuation discounts described above may allow you to transfer those partial interests at a lower valuation. These decisions must be made in the context of a particular business and a particular estate plan.