From time to time we have been asked why people get business appraisals. The most common reason is for tax compliance; usually for gift or estate taxes. Divorce is another common reason, but these are compliance appraisals, mandated by law, and not market-based. If you want to learn about the differences between market and compliance appraisals, you can check out Business Appraisals 101.
Today, however, we will list the top 5 reasons people get a market appraisal.
1) Sale of the Business
The most common reason for a market appraisal is the potential sale of the business. Typically it happens something like this. The business owner is minding his or her own…ahem…business, and then the phone rings. It is a business broker or “finder”, private-equity firm, competitor, or strategic buyer looking to see if the business owner is interested in selling. The owner is caught off guard, and reacts by hiring an appraiser to get an idea of a price the buyer might be willing to pay, before taking the conversation further. Less frequently, the business owner considers selling at some point in the near future, and hires a business appraiser to find out what his/her business is worth BEFORE actually deciding to sell. This is a more proactive approach, and while commendable, is considerably less common.
2) Partnership Buyouts (with or without Buy/Sell Agreements)
Partners go into business with excitement, aligned interests, and the best of intentions. However, disputes can arise, or interests simply diverge. Often, a health issue with one partner can affect the viability of the working partnership. In most cases, Buy/Sell Agreements are put in place at the beginning of the partnership. These are legally-binding agreements between the partners to decide how a business is to be bought and sold in a fair and equitable way between the partners, avoiding costly litigation. Most Buy/Sell Agreements stipulate the hiring of a business appraiser to establish the market value of the business. Some mandate that each partner hires their own business appraiser, and if the resulting values are close, they are averaged together. If not, a third appraiser is brought in to “break the tie.” With or without a Buy/Sell Agreement in place, a business appraisal is a critical step in ending the partnership without ending the business.
3) Buying a Business
Buying a business is probably the most important financial decision a person will make in their lifetime. Getting a business appraisal can put the buyer’s mind at ease, if the appraisal confirms they are buying the business at a fair price. It also can help keep a buyer from overpaying. Buyers who are smart enough to know what they don’t know, are typically more likely to seek out professional advice.
4) Retirement Planning
Retirement planning has become ever more popular over the years as the Baby Boom generation reaches retirement age. As people live longer and fuller lives, it has become apparent to Boomers and their retirement advisers that, unlike their parents’ generation, they’ll need their money to last decades after retirement. A core component of retirement planning is a full assessment of all assets, including privately-held businesses. Without an objective appraisal of a business asset, a retirement plan is all but useless.
5) Succession Planning
This is similar to retirement planning, except that a family member has been identified, and hopefully groomed, to take over the family business. Often, rather than gifting the business, the owner sells the business to the next generation at a fair price, but with favorable terms to the buyer (think little or no money down, and a long-term note). This provides the seller retirement income, while providing the buyer with financing and possible tax advantages, depending on the sale structure.
All of these reasons for a market appraisal have one thing in common…a transition of ownership. As the wave of Baby Boomers continue to retire in greater numbers over the coming decade, expect more small business transfers…and more market appraisals.