Ready to start writing your succession plan? I am. So let’s begin. The very first step is to set a fair market value for your business. By finding a fair and realistic value, you not only eliminate conflicts between partners and shareholders but perhaps more importantly you prevent problems with the IRS. If you do not set a fair value the IRS will establish one for you, usually at a much higher value than you would. This causes business owners to dispute the IRS findings. Such contests usually tie up your business for possibly years with legal battles in the courts. Much money could also be saved by finding a fair market value.
So what exactly is a fair market value? The often quoted definition is “the price at which property would change hands between a willing buyer and willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.
One often used approach is BOOK VALUE. This is the net worth statement of your business or, in other words, the amount you carry on your balance sheet.However, many owners stop here. Consider examining other factors.
Another viable method is CAPITALIZATION OF EARNINGS. In this approach you take the actual average annual earnings and multiply that figure by a realistic rate for your particular enterprise. One could use 10% for example.
Additionally, you could factor YEARS PURCHASED. Here you consider a very important concept, GOODWILL. Usually this takes your average annual earnings and multiplies it by the number of years expected to be valuable to your business.
CAUTION: The larger your business, the more important it becomes to have a professional appraiser value the business.
These methods represent a good start to set a value for your business. I have a FREE REPORT that I would be happy to share. It goes into greater detail and gives actual examples of the methods used. Please email me at rfowler@americanportfolios.com.
In summary, for your valuation to be accepted by the IRS, the following requirements should be met.
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The agreement must be a BONA FIDE business agreement.
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It must not be a device to transfer the business to family memebers for less than full and adequate consideration.
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The agreement must be reasonably comparable to others found in similar businesses.
Up next: Writing YOUR Buy-Sell Agreement.