Sweat Equity Evaporates in Business Evaluations

The Treasury definition (Reg. Sec. 20.2031-3) lays out the basic premise of the sale: “... the net amount which a willing purchaser ... would pay for the interest to a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” There’s not one single methodology in the valuation process. The America Society of Appraisers has categorized three valuation methodologies to assess the worth of your business: Income Based, Asset Based and Market Based. Watch the interview with entrepreneur and small business owner Caine Nakata as he explains these three valuation methods.http://rightonthemoneyshow.com/should-the-sale-of-your-business-be-your-retirement-plan-caine-nakata/ The income approach measures benefits coming into the business. The two most commonly used methods are capitalized returns and discounted future returns.

The asset approach looks at the underlying net value of the company’s tangible assets. If the business is to be continued after the owner’s death, the fair market value of the assets is commonly used. If the business were to be liquidated, a lower value would be used to compensate for the loss, which generally occurs with the forced sale of assets. The market approach is like valuing residential real estate. The sale house is compared to similar houses, which have recently sold. With the market approach, a search is made for similar companies with publicly traded stock and then the selling price of its shares is adjusted to account for any differences between the two companies. Business valuation is a tedious task for professionals and can be expensive. But there are good reasons to have your business evaluated. When the business is sold, the buyer will want a third-party valuation performed or an attorney to determine the total worth of the business owner’s estate. This is really important when the business is the largest asset in the estate. It’s also necessary for equal distribution of the estate to beneficiaries, some of which have or haven’t worked in the business. Sometimes it’s critical in retirement planning to determine if the exit strategy can fund retirement by itself and occasionally to determine lifetime gifts of the business. Whatever methodologies are used to determine the fair market value, it’s always seems undervalued and unfair to the owner.