No easy formula for appraising your business

Do you know what your business is worth or what it takes to maximize its value? Do you realize that your reported assets usually represent the least of your value and that cash flow is usually the most important value component? This comes into sharp focus for business owners who are older or faced with life changes, or confronted with business- changing issues and who have to determine when to sell or to which family member to hand the keys.

The saying that "this will one day all be yours, son/daughter" does not reflect taxes that may reduce business assets by as much as 50 percent.

Also, money causes family disputes.

Sometimes it's better to sell or give some ownership to family members or others, to family limited partnerships, or to trusts, prior to retirement (or worse), while still maintaining a measure of control.

Transfers of ownership should be documented to show the Internal Revenue Service that they were at fair market value, and not at some level that would create artificially low tax consequences.

Business appraisers frequently render opinions on fair market value.

That value is not fully reflected in financial statements.

Numerous approaches to valuing businesses include:

* capitalizing historic or future income or applying a multiple to income

* comparing the businesses to similar ones that have sold

* estimating the cost to create a similar business An appraiser should place himself or herself into the role of a buyer, seeking a return on investment over a "reasonable" period of time, at a "reasonable" risk.

An appraiser typically does not know what terms a real buyer would offer and how risky those terms would be.

Therefore, most appraisals present as cash value, ones that would be received by a seller in full at closing.

If there are no "reasonable" earnings, the appraiser may fall back on appraisals of the company's assets and liabilities.

A company's reported equity may not reflect assets that have been fully depreciated, or assets that have been depreciated on an accelerated tax basis but may retain much higher value.

On the other hand, there may be value issues with accounts receivables, with inventory, with private loans and with other balance sheet items.

Maybe the business only has income from patents, rents or dividends.

The same appraisal principles still apply.

What if it's a start-up? Approaches base on future earnings, market comparables and "cost to create" would apply.

Also, a business appraisal usually reflects the effects of competition, customer mix and concentration, access to capital, management depth, and other important issues.

It provides an outside perspective of someone who is trained and who may have analyzed hundreds of other companies, and probably many in your industry.

Some common ways to reduce your ownership include gifts or sales of stock to family members, transfers to trusts, to family limited partnerships, to limited liability companies, and to employee stock ownership plans.

The latter have good tax advantages but are relatively expensive to administer.

Here is the kicker! Did you know that if your 100 percent ownership is worth $1 million, a 49.9999 percent ownership interest may be worth as little as $250,000 in the market and not $499,999? That's because minority, or less-thancontrolling, interests do not have voting control over the decisions of the majority owner(s) and no outsider is likely to purchase minority interests in a privately held company at full value.

Appraisers therefore apply discounts for lack of control and for lack of marketability.

And they are accepted by the IRS.

Good for you! If your children don't have the funds to pay for the full value of the shares that you want to transfer to them, they can buy minority shares at a huge discount.

If you choose to give the shares to them, or anyone else, you will be limited to $10,000 per year per person without tax consequence, but you will be able to give more minority shares within your $10,000 limit.

These discounts can be applied to minority ownership interests in any business entity, be it a factory or a limited partnership holding real estate.

Fritz Strehlow is a managing director of The Mentor Group, Inc., a national valuation and investment banking firm.

He can be reached at 424-2848.