Why Business Valuation is a Prerequisite to Succession Planning

If you want to properly plan for your business’s future, you must know what it’s worth. While succession planning isn’t just about the numbers, the numbers are still important, and includes your valuation. Your business valuation dictates both the financial moves you need to plan for as well as the more subjective decisions about your family’s future.

Estate Tax Planning

When a small business owner passes away, their business interests become part of their estate. If the total estate is worth more than the estate tax exemption, estate taxes can be as high as 40%.

While 40% is a large portion of any estate, it can be devastating for a family business. Often, a small business owner’s business interest will make up the majority of their estate. When it comes time to pay the estate tax, the family may only have two choices — sell the business to raise cash to pay the tax or contribute their own funds (that they may not have) in order to keep the business.

Although most family businesses are worth less than the estate tax exemption, you need to know if there is a chance that your estate will be taxed so that you can make plans to cover the tax. If the initial interest in a business valuation is when your heirs go to settle your estate, they may have no choice but to sell the business.

Fairness in Gifts and Inheritances

There’s also a subjective element to estate and succession planning. If you have more than one heir, how will your estate be divided?

For example, assume you have two children, a $200,000 investment account, and a $1 million business. Is it fair to give the child who wants to follow in your footsteps the business and the other who wants to be a teacher the investment account? That’s for you to decide, but think of the resentment that could arise if you thought you were treating them equally because you didn’t know what your business was worth.

Another scenario could be where you simply state that your estate is to be divided equally between your children while your succession plan calls for only one child to take over the business operations. If your business makes up the bulk of your estate, the uninvolved children could force a sale to receive their share of the estate. If you recognize this problem in advance, you can come up with alternative arrangements such as giving the non-active children passive shares with dividend rights or creating a buy-sell agreement that doesn’t allow an immediate sale but allows them to be bought out with future profits.

Preparing for a Sale

The other key area where a business valuation is needed is when your succession plan calls for an eventual sale. This could be to a business partner or key employee as you plan for retirement, or you may wish to have your family buy into the business over time so they gain the same sense of ownership you have.

The purpose of the valuation isn’t just to get a fair price for your business, but so the potential owner has time to prepare. They will likely need time to save funds or to ensure they’ll be able to qualify for a business purchase loan when the time comes.

If the buyer doesn’t have the capital needed when the time comes, it could disrupt your succession plan. And of course, selling your business for less than it is worth because you never had a valuation performed could cause bad feelings among family members or other stakeholders.

Request a Business Valuation Consultation

You can’t finalize your succession planning until you know what your business is worth — both for financial purposes and to make sure everyone who supported you is treated fairly. To learn more about the business valuation process, talk to our Business Valuation experts today or view our recent webinar.



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