Business Valuation - Why Is It Important?
By Brad Gross

Do you know how much your construction company is worth? If you are not planning on selling it, do you even care? For reasons such as income, estate and gift taxes, banking, buy/sell agreements, stock option agreements, divorce proceedings, financial statement presentation and others, the answer is a resounding "Yes!" because you should care.

Income Taxes

Your construction company may have been in existence for many years with a respected name, repeat customers and a consistent profit margin. In the last three years, the company has had a profit after tax of over $1 million each year. You are considering allowing certain key employees to buy into the business. What value do you set on selling the stock to the key employees?
Assuming that you want to give them some or all of the stock as additional compensation, what amount do you add to their compensation and claim as a deduction on your business tax return?

Gift Taxes

At the same time, you are also beginning a gifting program to allow your children to become part owners in the business. If you just set a value without an independent appraisal, the chances are the Internal Revenue Service would succeed in challenging a value they considered too low. If you had an appraisal last year, can you use it for this year's gifts? How long is an appraisal useful? (Sixty days from the appraisal date.)

Estate Taxes

You met with your accountant and attorney to discuss estate planning. The first question they ask is how large is your estate? Your home and investments are relatively easy to value, but your business is easily worth more than $1 million, but you would not sell it for $5 million. So how much is it worth? An independent appraisal today would set a value that would allow you to plan more effectively for estate taxes. You would learn the potential estate tax on your estate and have time to structure your affairs in such a way to minimize the taxes. Your spouse and beneficiaries would not be surprised by a huge tax bill simply because the IRS valued your construction company significantly more than you expected.

Banking

A new investment opportunity has been presented to you. It is very attractive, but you do not have the requisite cash to invest today. Your bank has agreed to lend you up to 50 percent of the value of your business for this new investment. The same question keeps coming up: How much is the business worth? The bank cannot rely on your estimate and is not qualified to value the business itself. Because you do not have a current valuation, you must pass on this promising opportunity.

Buy/Sell Agreements

Your longtime partner and you have agreed that when you want to retire, he will buy out your interest in the business. You decided that you want to retire at the end of the year and inform your partner that you will sell him your interest for $5 million. He does not have the cash for the buyout and does not agree that the business is worth that much. He offers you $1 million. A formal buy/sell agreement with a required appraisal would have settled the price question and allowed him to acquire partial financing from a lender to fund the buyout. In addition, an appraisal done when the buy/sell agreement was first considered would have allowed him time to plan for the buyout with a reasonable estimate of the cash he would need.

Divorce

Over half of all marriages end in divorce, with over 1 million divorces occurring each year. If you are one of the unlucky couples, the value of your business will be determined in court for the property settlement. Although you may have agreements that prevent your spouse from taking the actual business, you may be required to buy out your spouse's community property interest. If so, do you know how that interest will be valued by an independent appraiser? Although your spouse's appraiser might differ from your appraiser, the amounts should be relatively close and would provide you with a number to use in planning.

Financial Statements

Recent changes in financial statement presentation require that goodwill be tested on a annual basis and written down if "impaired." If you are providing financial statements using generally accepted accounting principles, how will you determine if the goodwill on your books has been impaired? Publicly held construction companies have a higher reporting responsibility.
Remember, you must now sign a disclosure statement certifying the financial statements as correct because of the Sarbanes-Oxley Act. Without an independent appraisal, it is just your unsupported opinion that will be on trial.

These are just a few of the reasons to have an independent appraisal on a regular basis. Other reasons could be listed, but the point remains the same. Your personal opinion on the value of your business is not one that the IRS, the courts, banks or accountants can rely upon for their purposes.

If you don't know what value an independent appraiser would put on your construction company, you could be in for a nasty surprise.

Brad Gross specializes in providing tax and management consulting services to contractors as a member of the Dallas-based Lane Gorman Trubitt LLP accounting firm.