Business Succession Planning: Methods for Conducting a Comprehensive Business Valuation

Every company should have a plan for the future. Business succession planning is the process of creating a structure to ensure that there is a smooth transition of ownership/leadership—no matter what tomorrow brings. You cannot create a proper business succession plan unless you have a general understanding of the value of your company.

A comprehensive business valuation is essential. This raises an important question: How do you determine the value of a company? The answer is that there are actually several different strategies that are used for business valuations. In this article, our North Carolina estate planning lawyers provide an overview of the most common methods used to value small businesses.

As explained by Investopedia, a business valuation is the “general process of determining the economic value of a whole business or company unit.” As businesses are complicated assets, it is not always easy to put a definitive economic value on a company. There are a number of different strategies that can be used to value a business. Here is an explanation of the three main methods that business owners and entrepreneurs use to value companies:

1. Income-Based Approach: With the income-based approach, the total value of the company is estimated by looking at the present market value of the projected future cash flows of the business. Generally speaking, many business owners and investors prefer to use the income-based approach to determine the value of a business. If you are planning to sell a business as a single unit, it is likely that the counterparty/counterparties will lean towards the income-based approach in determining the proper price.
2. Market-Based Approach: With the market-based approach, the total value of a North Carolina business is determined based on what it would currently sell for as a collective unit or individual assets. Most often, this is done by looking up the sales price of similar companies/assets. A challenge for some small businesses is that there are not always good comparators available.
3. Cost-Based Approach: With the cost-based approach, the total value of a business is estimated by looking solely at assets and liabilities. This approach is more appropriate for companies that may be sold off as individual assets instead of as a single business unit. In some cases, the collective assets held by a business may actually be worth more than the business itself.

Business valuation is a combination of an “art” and a “science.” In other words, there is not necessarily always going to be a clear correct answer for how a business should be valued. In order to facilitate effective business succession planning, you and your team should focus your efforts on trying to come up with a business valuation that is as accurate as possible. If you have any specific concerns about business valuation, our Charlotte business succession planning lawyer can help.

Every business is different. In some cases, the use of a standard business valuation method—whether it is the income-based approach, market-based approach, or the cost-based approach—could result in an overestimate of the value of the business. This can pose a potential problem for business succession planning. To devise the best possible succession plan, you need an accurate assessment of the underlying value of your business. Valuation discounts help business owners, investors, and entrepreneurs “fine-tune” their judgments of small businesses and other closely-held corporations. Some examples of discounting strategies include:

• Control discounts;
• Marketability discounts;
• Blockage discounts; and
• Stock restrictions.

Ultimately, the goal of a business valuation remains the same: Make an accurate assessment of the underlying value of the company, both as a business unit and as a collection of assets. When decision-makers have correct financial information, they will be in a far better position to help steer the company in the right direction. Among other things, this includes ensuring that the company has an adequate business succession plan and business continuity plan in place.

At Arnold & Smith, PLLC, our Charlotte estate planning lawyers have extensive experience advising business owners on succession planning issues. If you have any questions about business succession planning and business valuation, we are here to provide support. Contact us today to schedule your confidential initial consultation. With law offices in Charlotte, Mooresville, and Monroe, our business succession planning team serves clients throughout the region, including in Belmont, Gastonia, Indian Trail, Albemarle, Davidson, and Huntersville.