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The importance of understanding valuation

As we stated in our last column, the first step in your succession plan should be to invest in an independent, reliable, unbiased business valuation by a firm that understands the LBM industry. Your business is likely your most valuable asset. Knowing its value is imperative because it fuels important decisions like tax planning, how to fund your post ownership goals, and determining and negotiating a sale price.

Before you hire a valuation specialist, it is important for you to know the different parameters for a valuation engagement. These include:

1.   Purpose of value: We define the reason for your valuation at the beginning of the engagement to provide transparency to all parties.

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2.   Type of value: We determine whether equity or enterprise value will be calculated.

3.   Discount for lack of control: If the interest to be valued is less than 50%, we will apply a discount for lack of control to arrive at the final value. We do this because a minority interest lacks the ability to control the operations of the business and therefore is less valuable to a potential buyer.

4.   Discount for lack of marketability: Because it is typically more difficult to find buyers for private businesses than public businesses, we may use a discount for lack of marketability to adjust your business value for the costs associated with selling a private business.

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Based on these parameters, there are different valuations that we perform throughout a typical succession planning engagement.

Initial conclusion of value: This valuation, conducted at the beginning of succession planning, calculates equity value, which allows us to determine the pre-tax amount of money the owner will have after paying off all liabilities. We use this value as the basis for our post-ownership cash flow analysis.

Buy-Sell/shareholder agreement value: If your business is owned by multiple people, you should have a buy-sell or shareholder agreement in place that determines how your business is valued if a trigger event occurs. The valuations for these agreements calculate equity value because a sell- ing owner will receive the equity value of their ownership interest as of the valuation date.

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Gift/Grant valuation: If we determine that you do not need the entire value of your business to fund your post-ownership goals and that your best transition option is to an internal buyer (e.g., family member or key employee), we will consider gifting or granting a portion of the business to the buyer to help mitigate taxes. In this case, we will make full use of discounts for lack of control and marketability to calculate the equity value of the gifted or granted interest. We do this because we can gift a larger portion of the business while using up less of your lifetime exemption or grant a larger portion of the business with less tax liability to your key employees.

Scenario valuations: During the succession planning pro- cess, we typically determine the top two or three transition options for your business and their values. For example, if we determine that one of the best options is a sale to your employees through an ESOP or worker-owned cooperative, we may grant a portion of the business to the eligible workers to acknowledge their past contributions and then sell the remainder of the business. We would calculate equity value and likely include discounts for the granted interest and potentially for the remaining interest if it was transitioned over multiple years.

Seller’s valuation: This valuation is based on the updated financials of your business and includes both enterprise and equity value. Typically, there are no explicit discounts included in a seller’s valuation. The value that is ultimately paid to you depends on who is buying your business. For example, most sales to third parties are transacted at enterprise value (equity plus debt) whereas most internal sales are transacted at equity value (assets minus debt).

We always encourage LBM dealers to get an independent, reliable, unbiased business valuation from a firm that specializes in the LBM industry. Just like it is hard to take a hike if you can’t find the trailhead, it is challenging to create a successful succession plan without knowing the current value of your business.

 

Stratus Wealth Advisors owner and founder Sam Brownell helps independent dealers by quarterbacking a comprehensive succession planning process to provide clients with essential data and advice to make the best decisions for their company and their family. Reach Sam at sbrownell@stratuswealthadvisors.com.

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